What is Options Trading? Call and Put Option Explained in Detail

15 mins read

Options trading lets traders buy or sell contracts to trade an asset at a set price before expiry. Used for hedging, speculation, and portfolio management, it enables profit from price movements without owning the asset, offering risk management and leverage.

What is Options Trading?

Options trading allows investors to buy or sell contracts that provide the right, but not the obligation, to purchase (call option) or sell (put option) an asset at a fixed price within a set period. This flexibility makes options a valuable tool for speculation, risk hedging, and boosting portfolio returns.

Options are derivative instruments, such as stocks, indices, commodities, or currencies. Options trading is different from buying and selling shares directly because it allows traders to gain exposure to stock price movements without actually owning the asset.

Important Terminologies in Options Trading

Strike Price: The strike price is the fixed price at which the option holder can buy/sell the underlying asset.

Premium: The premium is the cost paid to buy an option contract.

Lot Size: The lot size is the minimum number of units in an options contract.

Expiration Date: The expiration date is the date when the option contract expires.

Intrinsic Value: The intrinsic value is the actual value of an option if exercised.

Time Value: The portion of the option's premium that depends on the time left until expiration.

Bullish Traders: Bullish traders are traders who believe that prices will rise and take positions to profit from upward movements. They buy stocks, options, or futures, expecting gains.

Bearish Traders: Bearish traders are traders who anticipate price declines and take positions like short selling or buying put options to profit from falling markets.

Types of Options Trading in Share Market

Call Option

Gives the buyer the right (but not the obligation) to buy an asset at a predetermined price (strike price) before or on the expiration date. For example, if a stock is currently priced at ₹500, and you buy a call option with a strike price of ₹550, you can buy the stock at ₹550 if the price moves higher.

Put Option

Gives the buyer the right (but not the obligation) to sell an asset at a predetermined price before or on the expiration date. For example, if a stock is currently trading at ₹600, and you buy a put option with a strike price of ₹580, you can sell it at ₹580 even if the price falls further.

What is Strike Price in Options Trading?

The strike price is the predetermined price at which an options contract can be exercised. For a call option, it’s the price at which the buyer can purchase the underlying asset. For a put option, it’s the price at which the buyer can sell the underlying asset. It determines whether an option is in-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM) based on the current market price of the asset.

What is In-the-Money (ITM) in Options Trading? 

In-the-money (ITM) in Options Trading refers to an option that has intrinsic value, meaning it would be profitable if exercised immediately.

Call Option (ITM): The strike price is lower than the current market price of the underlying asset.

Put Option (ITM): The strike price is higher than the current market price of the underlying asset.

If a stock is trading at ₹200:

A call option with a strike price of ₹180 is ITM because the buyer can purchase at ₹180 and sell at ₹200.

A put option with a strike price of ₹220 is ITM because the buyer can sell at ₹220 while the market price is ₹200.

What is At-the-Money (ATM) in Options Trading? 

At-the-Money (ATM) in options trading refers to a situation where the strike price of an option is equal (or very close) to the current market price of the underlying asset.

An ATM option has no intrinsic value but may still have time value. It is commonly used for high liquidity and hedging strategies. ATM options are more sensitive to market movements, making them useful for short-term trades.

If a stock is currently trading at ₹200, then:

A Call Option with a ₹200 strike price is ATM. A Put Option with a ₹200 strike price is also ATM.

What is Out-of-the-Money (OTM) in Options Trading?

Out-of-the-Money (OTM) in Options Trading refers to options that have no intrinsic value because exercising them wouldn't be profitable at the current market price.

OTM Call Option: A Call Option is OTM if the strike price is higher than the current market price of the underlying asset. For example, if a stock is trading at ₹200, a Call Option with a ₹220 strike price is OTM.

OTM Put Option: A Put Option is OTM if the strike price is lower than the current market price. For example, if a stock is at ₹200, a Put Option with a ₹180 strike price is OTM. Since OTM options lack intrinsic value, their price consists only of time value and is generally cheaper than ITM or ATM options. Traders use them for speculation or hedging at lower costs.

ITM, ATM, and OTM for Call Options (Bullish Traders)

In-the-Money (ITM) Call Option: Profitable Scenario

The stock price is higher than the strike price. The option has intrinsic value, making it more expensive. ITM call options have a high premium but a greater chance of success. Let us take for example the Strike Price as ₹1,000 and the Current Market Price as ₹1,100. This call option is ITM, as the buyer can buy at ₹1,000 and sell at ₹1,100, making a profit.

At-the-Money (ATM) Call Option: Break-Even Scenario

The stock price is equal to the strike price. The option has no intrinsic value, only time value. Traders wait for a price move to turn profitable. Let us take this example where the Strike Price is ₹1,000, Current Market Price is ₹1,000. Since the stock price is the same, the option neither profits nor loses (excluding the premium paid).

Out-of-the-Money (OTM) Call Option: Loss Scenario

The stock price is below the strike price. The option has no intrinsic value, only time value. If the stock doesn’t rise above the strike price, the option expires worthless. Let us assume an example where the Strike Price is ₹1,000, and the Current Market Price is ₹950. Here the buyer won't exercise the option because buying at ₹1,000 is not profitable when the market price is ₹950. The loss equals the premium paid.

ITM, ATM, and OTM for Put Options (Bearish Traders)

In-the-Money (ITM) Put Option: Profitable Scenario

The stock price is lower than the strike price. The option has intrinsic value, making it more expensive. ITM put options have a higher premium but a greater probability of profit. Let us assume an example where Strike Price is ₹1,000, and the Current Market Price is ₹900. The trader can sell at ₹1,000 while the market price is ₹900, making a profit.

At-the-Money (ATM) Put Option: Break-Even Scenario

The stock price is equal to the strike price. The option has only time value but no intrinsic value. Traders wait for a downward movement to profit. Let us assume the Strike Price as ₹1,000 and the Current Market Price as ₹1,000. Since selling at ₹1,000 in a ₹1,000 market is neutral, no gain or loss occurs (excluding the premium paid).

Out-of-the-Money (OTM) Put Option: Loss Scenario

The stock price is higher than the strike price. The option has no intrinsic value, only time value. If the stock doesn’t fall below the strike price, the option expires worthless. Let us assume the Strike Price as ₹1,000 and the Current Market Price as ₹1,100. Here, the trader won’t exercise the option since selling at ₹1,000 is a loss when the market is at ₹1,100. The loss equals the premium paid.

Effect of ITM, ATM, and OTM in Options Trading

Premium Costs and Liquidity

ITM Options: Higher premium but a higher chance of profit.

ATM Options: Moderate premium with a balanced risk reward.

OTM Options: Lower premium but riskier since they expire worthless more often.

Option Sellers’ Perspective

ITM options are risky because they must pay the intrinsic value if exercised. OTM options favor sellers since they expire worthless, letting them keep the premium. ATM options have moderate risk as price movement decides profitability.

Profitability Scenarios in Options Trading

Bull Market (Stock is Rising)

Buy ITM or ATM call options: Higher probability of profit.

Sell OTM put options: They will expire worthless, letting sellers keep the premium.

Bear Market (Stock is Falling)

Buy ITM or ATM put options: Higher probability of profit.

Sell OTM call options: They expire worthless, benefiting sellers.

Sideways Market (No Major Price Movements)

ATM options will lose time value due to theta decay (time decay). OTM options will lose all value if the market doesn’t move favorably. Traders use option spreads (straddles or strangles) to profit from low volatility.

Delta, Gamma, Theta, Vega, and Rho in Trading Options

Option Greeks are key risk measures that help traders analyze how different factors affect the price of an option. They provide insights into price movement, volatility impact, time decay, and sensitivity to interest rates. Understanding these Greeks is essential for making informed trading decisions.

Delta (Δ) Price Sensitivity: Delta measures how much the price of an option will change for every ₹1 movement in the underlying asset. If an option has a Delta of 0.5, its price will rise by ₹0.50 for every ₹1 increase in the stock price.

Gamma (Γ) Delta’s Rate of Change: Gamma tracks how much Delta changes as the underlying asset moves, helping traders assess Delta's stability. A higher Gamma means Delta adjusts quickly, leading to more sensitivity in option pricing.

Theta (Θ) Time Decay: Theta represents the loss in an option’s value as time passes, assuming all other factors remain constant. If the Theta is -0.05, the option price decreases by ₹0.05 per day due to time decay.

Vega (V) Sensitivity to Volatility: Vega indicates how much an option's price changes with a 1% shift in implied volatility. If Vega is 0.10, the option price will increase by ₹0.10 when volatility rises by 1%.

Rho (ρ) Impact of Interest Rates: Rho measures the effect of interest rate changes on option prices. If Rho is 0.02, the option price will increase by ₹0.02 for every 1% rise in interest rates.

Types of Models in Options Trading

Below are some key models used in options trading, along with brief explanations. Each model has strengths and weaknesses, and traders choose them based on their specific needs and market conditions.

Black-Scholes Model (BSM): A widely used model for pricing European options. Assumes constant volatility and no early exercise. It calculates theoretical option prices based on stock price, strike price, time to expiration, risk-free rate, and volatility.

Binomial Options Pricing Model (BOPM): Uses a step-by-step approach to model price movements. Represents stock price changes in a binomial tree (up/down movements). Useful for pricing American options, which can be exercised anytime before expiry.

Monte Carlo Simulation: Uses random simulations to estimate option prices. Particularly useful for complex derivatives and exotic options. Helps in pricing options with multiple influencing factors and unpredictable price paths.

Heston Model: A volatility-based model that assumes volatility is not constant but stochastic (random). More realistic than the Black-Scholes model for pricing options in volatile markets.

GARCH Model (Generalized Autoregressive Conditional Heteroskedasticity): Focuses on predicting volatility changes over time. Used to estimate future volatility based on historical price fluctuations. Helps traders and risk managers adjust their strategies based on expected market conditions.

Important Strategies for Options Trading 

Buying a Call Option (Bullish Strategy): Suitable when expecting an increase in stock price. Limited risk (premium paid), unlimited profit potential.

Buying a Put Option (Bearish Strategy): Used when anticipating a price drop. Limited risk (premium paid), unlimited profit potential.

Covered Call Strategy (Income Generation): Sell a call option while holding the underlying stock. Generates income but limits profit potential.

Protective Put Strategy (Hedging Losses): Buy a put option while holding a stock. Protects against downside risk.

Straddle (High Volatility Strategy): Buy both a call and put option at the same strike price. Profitable in cases of high price movement (up or down).

Strangle (Lower-Cost Volatility Play): Buy a call option at a higher strike price and a put option at a lower strike price. Requires significant movement in either direction.

Iron Condor (Low Volatility Strategy): Sell both a lower and higher strike price put and call option. Used in a stable market to earn premiums.

Styles of Options Trading

American Options: These can be exercised at any time up to and including the expiration date, offering greater flexibility.

European Options: These can only be exercised on the expiration date, providing less flexibility but often simpler pricing models.

Bermudan Options: These can be exercised on specific dates prior to expiration, combining features of both American and European styles.

Asian Options: The payoff depends on the average price of the underlying asset over a certain period, reducing the impact of volatility.

Barrier Options: These become active or inactive only if the underlying asset reaches a predetermined price level, introducing conditionality to the contract.

Binary Options: These provide a fixed payout if a certain condition is met at expiration; otherwise, they expire worthless.

Options Trading in India

In India, options trading is primarily conducted on stock exchanges like NSE (National Stock Exchange) and BSE (Bombay Stock Exchange). The regulatory body for options trading in India is the Securities and Exchange Board of India (SEBI).

Options contracts are cash-settled, meaning no actual delivery of shares takes place. Options expire on the last Thursday of the expiry month in India.

Equity Options: Options contracts on individual stocks (e.g., TCS, Reliance, HDFC Bank).

Index Options: Options based on indices such as Nifty 50, Bank Nifty, and Sensex.

Commodity & Currency Options: Options on commodities like gold, silver, and crude oil, as well as currency pairs like USD/INR.

How to Start Options Trading in India?

Options trading in India is regulated by SEBI (Securities and Exchange Board of India) and takes place on exchanges like NSE (National Stock Exchange) and BSE (Bombay Stock Exchange). Here’s a step-by-step guide to get started:

Learn the Basics of Options Trading: Before trading, understand key concepts like Call & Put options, Strike Price, Premium, Expiry Date, ITM/ATM/OTM options, and Option Greeks (Delta, Gamma, Theta, Vega, Rho).

Open a Trading & Demat Account: Choose a SEBI-registered broker (e.g., Zerodha, Upstox, Angel One, ICICI Direct). Submit KYC documents (PAN card, Aadhaar, bank details, and income proof). Activate F&O (Futures & Options) segment by providing proof of income (bank statements, ITR, salary slips).

Fund Your Trading Account: Deposit funds in your trading account to cover premium costs, margin requirements, and other charges.

Choose a Stock or Index Option: Trade Stock Options (e.g., Reliance, TCS, Infosys) or Index Options (Nifty 50, Bank Nifty). Select an expiry date (weekly/monthly) and a strike price based on your strategy.

Place an Options Trade: For the Buying Options, pay the premium and get the right (but not obligation) to exercise the contract. For the Selling Options, collect the premium but take on higher risk. Use limit orders or market orders to execute trades through your broker’s platform.

Monitor and Manage Risks: Track your trades and exit before expiry if needed. Use stop-loss orders to minimize losses. Follow option trading strategies like Covered Calls, Iron Condors, and Strangles.

Close or Exercise the Position: Most traders square off their positions before expiry to avoid settlement complications. If holding until expiry, settlement occurs as per exchange rules (cash settlement for index options, physical settlement for stock options).

Advantages and Disadvantages of Options Trading

Conclusion

Options trading provides flexibility, leverage, and risk management opportunities, making it useful for hedging and speculation. However, it involves complexities like time decay and volatility risks. Success requires a solid understanding of strategies, pricing models, and risk management. 

Beginners should start with the basics, while experienced traders can refine techniques using advanced strategies. With the right approach, options trading can enhance a portfolio in various market conditions.

A Quick Quiz to Test Yourself Now!

Frequently Asked Questions (FAQs)

1. What is options trading?

Options trading involves buying and selling contracts that give the right, but not the obligation, to buy or sell an asset at a predetermined price before expiration.

2. How is options trading different from stock trading?

Unlike stocks, options have an expiration date and provide leverage, allowing traders to control larger positions with less capital.

3. What are call and put options?

A call option gives the right to buy an asset at a set price, while a put option gives the right to sell an asset at a set price before expiration.

4. Is options trading risky?

Yes, options can be risky due to time decay, volatility, and leverage. However, strategies like hedging and spreads can help manage risk.

5. How do I start trading options in India?

To start, open a trading and Demat account with a SEBI-registered broker, complete the KYC process, learn basic strategies, and practice before trading with real money.

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