The best option for beginners is to keep it simple. The following options trading strategies are designed for beginners and are "one-legged," which means they use just one option in the trade.
In the true sense, there are only two types of Options i.e Call Put Options. We will understand them in more detail.
Call Option
A Call Option is an option to buy an underlying Stock on or before its expiration date. At the time of buying a Call Option, you pay a certain amount of premium to the seller which grants you the right (but not the obligation) to buy the underlying stock at a specified price (strike price).
Purchasing a call option means that you are bullish about the market and hoping that the price of the underlying stock may go up. In order for you to make a profit, the price of the stock should go higher than the strike price plus the premium of the call option that you have purchased before or at the time of its expiration.
Put Option
In contrast, a Put Option is an option to sell an underlying Stock on or before its expiration date. Purchasing a Put Option means that you are bearish about the market and hoping that the price of the underlying stock may go down.
Put-Call Options from the buyers' point of view
In order for you to make a profit, the price of the stock should go down from the strike price plus the premium of the Put Option that you have purchased before or at the time of its expiration.
In this manner, both Put and Call option buyer’s loss is limited to the premium paid but profit is unlimited. The above explanations were from the buyer's point of view.
Put-Call Options from the sellers' point of view
We will now understand the put-call options from the seller’s point of view, ie options writers. The Put option seller, in return for the premium charged, is obligated to buy the underlying asset at the strike price.
Similarly, the Call option seller, in return for the premium charged, is obligated to sell the underlying asset at the strike price.
Visualize options profit and loss
Is there a way to visualise the potential profit/loss of an option buyer or seller? Actually, there is.
An option payoff diagram is a graphical representation of the net Profit/Loss made by the option buyers and sellers.
Before we go through the diagrams, let’s understand what the four terms mean. As we know that going short means selling and going long means buying the asset, the same principle applies to options. Keeping this in mind, we will go through the four terms.
- Short call - Here we are betting that the prices will fall and hence, a short call means you are selling calls.
- Short put - Here the short put means we are selling a put option
- Long call - it means that we are buying a call option since we are optimistic about the underlying asset’s share price
- Long put - Here we are buying a put option.
Options Payoff diagram
where,
S = Underlying Price
X = Strike Price
Break-even point is that point at which you make no profit or no loss.
The long call holder makes a profit equal to the stock price at expiration minus strike price minus premium if the option is in the money. Call option holder makes a loss equal to the amount of premium if the option expires out of money and the writer of the option makes a flat profit equal to the option premium.
Similarly, for the put option buyer, profit is made when the option is in the money and is equal to the strike price minus the stock price at expiration minus premium. And, the put writer makes a profit equal to the premium for the option.
All right, until now we have been going through a lot of theory. Let’s switch gears for a minute and come to the real world. How do options look like? Well, let’s find out.
