A Complete Beginner's Guide: How to Do Options Trading Step by Step

Are you interested in exploring the world of options trading in the Indian stock market? We are here to guide you step by step through the basics. Now, let's keep it simple and easy to understand, perfect for new traders.

What are the Options?

An option is a type of financial contract that gives you the right, but not the obligation, to buy or sell a stock, ETF, commodity, currency, or benchmark at a specific price within a certain time frame.

One could say it's a coupon for stocks. There are two basic types of options:

• Call Options: It grants the right to buy an asset.
• Put Options: It gives the right to sell an asset.

The options contract expires at a fixed date, generally the last Thursday of any calendar month in India. On that date, the contract is said to have expired, and its value is zero.

How Does Options Trading Differ from Stock Trading?

When you options trading, you are in the exercise of the option, and only then will you own the shares. One major difference from traditional stock trading, where you literally become a part owner of the company once you buy the shares, with options, you are showing your interest to potentially buy (or sell) the company's shares at some point in the future.

Why Trade Options?

• Options trading is quite exciting for several reasons
• You can earn money if the stocks go high, low, or sideways.
• You can limit the risk amount to a known amount of premium you pay.
• You can probably make more than what the regular trading of stock makes.
• It helps to enjoy leverage where you can have control of a larger position with fewer capitals.
• It gives flexibility and a number of strategies based on market situations.

Pre-Trade Options Trading in India

Step 1: Eligibility criteria

• First and foremost, ensure you meet these requirements:
• You are over 18 years old.
• You have a PAN card
• You have an account in Demat and trading with a trading broker.

Step 2: Learn About Options Trading

• Knowledge is power. You have to know the following about options trading
• Basic terms-strike price, expiry date, and premium.
• Factors that affect option prices.
• Options trading strategies.
• The "Greeks" - delta, gamma, theta, vega, which determine the prices of the options.
• Free online resources or courses provided by the stock exchange/brokers.

Step 3: Select a Reputed Broker

• Select a reputed broker that offers options trading. You ought to look for:
• Low brokerage
• Relatively easy-to-use trading platform
• Good customer care
• Educational material
• Some of the reputed brokerages in India are Zerodha, Upstox, and ICICI Direct.

Step 4: Open a Trading Account

• In order to open an account, the following processes will be carried out
• Applying for the account through an application form
• Upload KYC documents such as proof of identity and proof of residence.
• Conclusion on the Onsite Verification Process

Step 5: Fund Your Account

• Fund your trading account with money. Invest a small amount that you can afford to lose.

Step 6: Options Contracts in India

In the Indian market:

• Equity options are European-type. These options can only be exercised on the expiry date.
• Index options, like Nifty and Bank Nifty, are also of European type.
• Stock options are American-type. One can exercise the right at any time before the expiry date.
• Settled via cash.
• Lot size varies for every stock.
• Options expire on the last Thursday of each month.

Step 7: Understand Option Trading Levels

Trading levels are assigned by the brokers in order to authorize the following types of option trades:

• Level 1: Execute covered calls and protective puts
• Level 2: Level 1 + buy calls or puts; open long straddles and strangles
• Level 3: Level 2 + long open spreads; long-side ratio spreads
• Level 4: Level 3 + use uncovered options, short straddles and strangles, and uncovered ratio spreads

You'll likely start at one of the earlier levels as a new trader.

Step 8: Paper Trading

• Simulate trading with virtual money before risking live money.
• Many brokers will offer you a virtual trading environment where you can test strategies without risking a thing.

Step 9: Place Your First Live Trade

When you feel that you are prepared to trade live:

• Log into your trading platform.
• Select the stock or index that you want to trade options.
• Determine if you are going to buy or sell a call or put an option
• Select the strike price and expiry date
• Decide how many lots you want to trade
• Enter your order

Step 10: Keep Tracking Your Trade

Start monitoring your trade since options prices change when there is a movement of the underlying asset.

Step 11: Closing Position

• You can close your position in either of these two ways
• Sell your option prior to expiry.
• Let it expire (it will automatically settle if it is in the money).

Simple Options Trading Strategies

Here are some of the simple strategies to get you started:

1. Long Call

• Use: When you anticipate a significant hike in the stock price.
• Operation: Buy a call option.
• Maximum Loss: Limited to the premium paid.
• Maximum Profit: Theoretically unlimited.

2. Long Put

• Use: When you expect a major drop in the stock price.
• How it works: Buy a put option.
• Maximum loss: This is capped at the premium paid.
• Maximum profit: Capped (since the stock cannot drop below zero).

3. Covered Call

• When to use: You already own the stock and do not foresee a large price rise in the short run.
• How it works: You own the stock and sell a call option against it.
• Maximum loss: You are capping this with stock ownership.
• Maximum profit: This is capped at the strike price plus the premium received.

4. Protective Put

• Use: You are a holder of the stock and feel the need to hedge against loss.
• How: Hold the stock and acquire put on that stock.
• Maximum Loss: It depends upon the difference between the stock price and the put strike price plus the premium paid.
• Maximum Profit: Unlimited but puts premium.

Important Rules and Regulations in India

SEBI Regulations: Options trade is governed by the SEBI. SEBI directives and norms have to be taken care of.

Margin requirements: You have to keep a minimum amount of money in your account when making an options trade. The margin depends on the type of trade you are doing.

Position Limits: Position limits are how many contracts you are supposed to hold. This actually is a check on the market manipulation of a particular stock.

Trading Hours: Options trading is allowed from 9:15 AM to 3:30 PM, Monday to Friday but remains closed on holidays.

STT and Taxes: One has to pay Securities Transaction Tax on the trades. The profits earned in options trading are subject to capital gains tax, too.

Risk Management Tips

Trade with Minimum Capital: Start with as little capital as possible until you gain some experience.

Make Use of Stop-Loss Orders: This would automatically close the trade if losses reach a certain limit.

Never Overtrade: Focus on a few good quality trades rather than a lot of unwell-researched ones.

Diversification: Do not put all your money into a single trade or strategy.

Continual Learning: The market is always under transformation. Be updated with new information and strategies.

Mistakes to Avoid while Trading

1. Trading Without Knowledge: One may not jump in without understanding the basics.
2. Ignoring the Greeks: Delta, Gamma, Theta, and Vega all affect the option prices.
3. Overlooking Implied Volatility: High implied volatility makes options pretty costly.
4. Holding Till Expiry: Time decay accelerates as the expiry date is approaching. In some situations, it is better to close early.
5. Lacking a Plan: Always have an entry and exit strategy before trading.

Trading options can indeed be a highly rewarding avenue in the Indian stock market, so much so with flexibility, leverage, and also great returns. However, it poses some risks to counter those gains. So, start slow, keep learning, and always trade responsibly.

Conclusion

Options trading is one of the most rewarding options to trade in the Indian stock market. It offers flexibility, leverage, and the possibility of reaping good returns. But it does come with risks. So first off, start slow, then just keep learning, and trade responsibly.

Remember, though this guide is but a start, to really keep going, knowing the latest in market trends and regulation will be enough. And as you gain experience in trading, you can unleash some of the more complex strategies and fine-tune your approach.

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Happy trading, and may your options always be in the money!