Options Trading In India: A Beginner's Guide To Investing

Options trading in India has been around since 2001, but it was only in 2006 that the market saw real liquidity. The options market makes up a significant part of the derivative market in India, with nearly 80% of derivatives traded being options.

Options are a form of contract that gives you the right to buy or sell an amount of stock at a pre-determined price, without any obligation to buy or sell the stock. There are two types of options: call options and put options. A call option gives you the right to buy a stock, while a put option gives you the right to sell the stock.

To trade options in India, you need to have a trading account with a broker like Zerodha or Upstox. You will also need to have a certain amount of margin money, which is the amount of money you need to have in your account to cover potential losses. The margin requirements are often a percentage of the total value of your open positions and can range from 15% to as high as 60% in times of extreme volatility.

When trading options, you can either buy or sell the options contract. As a buyer, you pay a premium for the option, which is a non-refundable fee. The seller of the option, also known as the writer, receives this premium and is obligated to sell the option if the buyer chooses to exercise their right.

There are various strategies that can be employed when trading options, depending on whether you predict a rise or fall in stock prices or volatility in the underlying asset's price. It is important to understand the risks involved and have a clear strategy before trading options.

The basics of options trading

Options trading is a form of contract that gives you the right to buy or sell an amount of stock at a pre-determined price. However, you are not obliged to buy or sell the stock. Options trading is also known as derivatives trading because the options contracts derive their value from the underlying instruments.

There are two types of options: call options and put options. A call option gives you the right to buy shares before the expiry date, whereas a put option gives you the right to sell shares before the expiry date.

Trading in options does not mean that you have to exercise the right to buy or sell. In day trading options, you simply buy or sell options without worrying about exercising your rights. Options give you the power to buy a higher number of shares for a small amount of money (called a premium) in comparison to buying a stock.

For example, you can buy one call option contract of Reliance by paying Rs. 72.50 for a particular strike price that has 505 underlying Reliance shares. A reliance call option with a strike price of Rs. 1900 gives you the right to purchase 505 Reliance shares at Rs. 1900 irrespective of the current stock price.

To trade options, you need to have a trading account with a top stockbroker like Zerodha or Upstox. Options contracts are cash-settled, and there is no delivery of underlying instruments, which means you do not require a Demat account. A trading account linked with your bank account is sufficient to trade options.

Trading in options is done in lots. A single lot size contains a fixed number of underlying instruments. For example, 1 lot of Infosys call or put options has 1200 underlying Infosys shares.

Options trading involves a higher amount of risk due to the large number of underlying instruments and volatility. For buying options contracts, you may need a small amount equal to the premium amount multiplied by the underlying contract value. For example, to buy 1 lot of Bank Nifty Call options (that has an underlying value of 25) and a current premium trading at Rs. 700, you need to have Rs. 17,500 cash in your account.

Selling options contracts have exchange-stipulated margin requirements based on the volatility of the underlying instruments, which are higher compared to buying options. In general, you need to keep at least Rs. 1.5-2 Lakhs of funds in your trading account depending on your trading requirements.

There are at least 15-20 call options available on a particular stock. For trading options, you need to have the most liquid options contract so that you can buy or sell at any moment. Generally, the options with a strike price near the current stock price are the most liquid.

You can do either day trading or positional trading in options depending on your trading strategy. Options day trading involves buying or selling a particular option contract, similar to day trading of stocks. You need to have a view of the particular stock and trade according to the price action.

Positional trading in options involves buying or selling multiple options to form an option strategy such that you have positive cash flows until the options are held. The option positions are built after taking a view on the particular index or stock. Here, multiple options are used to restrict the loss.

Options trading has the potential to generate multifold returns if practised correctly. It can be a means to diversify your trading portfolio, but you need to have a clear strategy and a disciplined approach.

How to open an options trading account

To open an options trading account in India, you will need to follow these steps:

• Choose a stockbroker: Select a reputable stockbroker that offers options trading, such as Zerodha or Upstox.
• Gather required documents: You will need to provide a cancelled cheque showing your IFSC or MICR code, salary slip, IT return, or Form-16 for the F&O (derivatives) segment.
• Open a trading account: Visit the website of your chosen stockbroker and follow their account opening process. Ensure that you select F&O (derivatives) during the account opening.
• Fund your account: Options trading requires a minimum balance of Rs. 1.5 to 2 lakhs. You can use the funding options provided by your stockbroker to add funds to your account.
• Create a watchlist: Identify the most liquid options that you want to trade, such as those with high volume or strike prices near the current stock price. You can use resources like NSE India or MoneyControl to find this information.
• Start trading: Once your account is funded and you have a watchlist, you can begin placing buy or sell orders for options. Remember to consider your risk tolerance and investment goals when making trades.

Understanding margin money

Margin money is an important aspect of options trading in India, and it's crucial to understand its role to manage your money effectively. Margin money refers to the cash or security that a trader needs to deposit in their account when trading options. This acts as collateral for the trade and is separate from the premium amount. The margin requirements are set by the BSE and NSE in India and can vary depending on the type of option and the underlying asset.

For buying options contracts, the margin money required is typically the premium amount multiplied by the underlying contract value. For example, if you want to buy one lot of Bank Nifty Call options with an underlying value of 25 and a premium of Rs. 700, you would need Rs. 17,500 in your account.

On the other hand, selling options contracts usually have higher margin requirements due to the greater risks involved. These requirements are stipulated by the exchange and are based on the volatility of the underlying instruments. For instance, if you want to sell options contracts, you should generally keep Rs. 1.5 to 2 lakhs in your trading account to cover the margin needs.

It's important to note that not maintaining the required margins can result in trade cancellation or fines imposed by the exchanges. Therefore, understanding and calculating margins correctly is essential for successful options trading in India.

When it comes to buying and selling call options, there are specific margin requirements for both buyers and sellers. As a buyer, you only pay the premium for the option, which is transferred to the broker of the option seller. Your liability is limited to this premium amount. However, as a seller (also known as the writer), you have limited gains but potentially unlimited losses. To mitigate this risk, you must deposit a margin with the exchange, which acts as security against adverse price movements. The margin amount is typically a percentage of the total value of your open positions and is influenced by the volatility of the option's price.

Finding liquid options for trading

When trading options, it is crucial to select the most liquid options contracts to ensure you can buy or sell at any time. Generally, options with a strike price close to the current stock price are the most liquid. To identify these liquid options, you can refer to resources such as NSE India or MoneyControl, which provide details of the most active option contracts.

To further enhance your ability to find liquid options for trading, consider the following strategies:

• Monitor Stock Liquidity: Stock market liquidity refers to the ease with which a stock can be bought or sold without significantly impacting its price. Factors such as the company's size, the number of outstanding shares, and investor interest influence liquidity. Blue-chip companies with large market capitalisation and strong financials often offer more liquid stocks.
• Analyse Trading Volume and Bid-Ask Spreads: Liquid stocks are characterised by high trading volume, indicating active trading by a large number of investors. Additionally, liquid stocks tend to have narrower bid-ask spreads, which represent the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept.
• Utilise Trading Tools: Websites like NSE India and MoneyControl provide valuable information on the most active call and put option contracts, helping you identify liquid options.
• Focus on Blue-Chip Companies: Blue-chip companies with strong financials and large market capitalisation often have liquid stocks. These companies are popular among investors due to their ease of buying and selling, low transaction costs, and price stability.
• Consider Exchange Indices: Exchange indices like SENSEX, NIFTY, Bank NIFTY, and others include the most traded stocks in the market. By studying these indices, you can identify liquid stocks with high trading volume.
• Use Data Analysis and Trading Charts: Data analysis and trading charts can aid in identifying liquid stocks by providing insights into trading patterns and volume.
• Select Highly Traded Blue-Chip Companies: Even among blue-chip companies, some stocks may not be traded frequently in options. Therefore, it is essential to refer to resources like the NSE site, which provides information on the most active securities and contracts, helping you identify liquid options within blue-chip companies.

By incorporating these strategies into your investment approach, you will be better equipped to find liquid options for trading and make more informed investment decisions.

Options trading tips

• Understand the basics: Before you start trading in options, it is important to get your basics right. Understand the concepts of futures and options, the underlying assets, and the risks involved.
• Choose the right broker: Options trading requires a trading account with a reputable broker like Zerodha or Upstox. Compare the fees and features offered by different brokers before opening an account.
• Manage risk: Options trading involves a high amount of risk due to the large number of underlying instruments and market volatility. Always use a stop-loss order to limit potential losses.
• Have sufficient capital: Trading in options requires a significant amount of capital. Make sure you have enough funds in your account to cover the margin requirements and potential losses.
• Do your research: Analyze the underlying assets, market trends, and option contracts before placing a trade. Use technical analysis tools and indicators to make informed decisions.
• Have a trading strategy: Develop a well-defined trading strategy that suits your risk appetite and investment goals. You can use strategies such as bull call spreads, bear put spreads, or straddle strategies, depending on your market outlook.
• Monitor your trades: Options trading requires active monitoring of your positions. Keep track of the underlying asset's price movements and be prepared to adjust your trades as needed.
• Understand the tax implications: Options trading may have tax implications, so be sure to consult with a tax advisor to understand the tax treatment of your trades.
• Practice good risk management: Do not put all your capital into a single trade. Allocate a small percentage of your capital to each trade to manage your risk effectively. Diversify your trades across different underlying assets to reduce risk.
• Stay disciplined: Stick to your trading plan and avoid making impulsive decisions. Have a disciplined approach to trading and follow your entry and exit strategies consistently.

Frequently asked questions