What is Option Trading? | A Comprehensive Guide For Beginners 2025

In contrast to stock trading, where investors can buy and sell equity shares, option trading allows participants to trade option contracts. These option contracts are a prevalent financial instrument that allows investors to maximise their earnings. Scroll down through the article to learn everything you need to know about option trading. 

What is Option Trading?

Option trading is the buying and selling of option contracts tied to an underlying asset in the Indian stock market. Option trading contracts grant the buyer the right but not the obligation to buy or sell an underlying asset within a specified period. The price at which it is traded is predetermined and agreed upon by both the parties involved. The underlying asset could be from a wide range of financial instruments, such as commodities, stocks, currencies, or indices. To participate in option trading, the holder has to pay a premium for possessing this right. The authority to leverage this right is completely dependent on the option holder. 

If the market situations are favorable, the holder can execute the contract within the specified timeframe. On the contrary, if market conditions turn out to be unfavorable, the holder can choose not to exercise the option and let the contract expire. This ensures that the premium amount does not exceed the potential losses that could be incurred by executing the contract in unfavorable market dynamics.

Call option VS Put option: Key Differences

There are two types of contracts in option trading, call and put option.

• Call option:

The call option provides the holder with the right to buy an underlying asset within the set timeframe at a predetermined price. Since the holders do not have an obligation to execute these types of option contracts, they can decide to buy according to market conditions. These are usually leveraged when the investor expects the price of the underlying asset to increase in the future. 

• Put option:

Put options give the holder the right but not the obligation to sell the underlying asset in the future before the expiration date. They are typically used when an investor anticipates that the price of the underlying asset will fall.

Stock Trading VS Option Trading

Stock trading involves the buying and selling of stocks of publicly listed companies through regulated stock exchanges. The stocks held by an investor represent that the individual has purchased a small portion of the company’s equity ownership. Additionally, the profit gained by investors is directly dependent on the company’s performance.

If the company’s overall profitability has increased, the prices of stocks held by the investors will also increase and vice versa. Stock trading is mostly preferred by conservative investors who usually aim for long-term investments.

On the contrary, option trading involves buying and selling option contracts. These contracts give the buyer the right but not the obligation to buy or sell an underlying asset at a predetermined price before the expiry date. Since the level of risk involved is high, option trading is preferred by investors with greater levels of risk appetite. Additionally, option trading strategies are used for hedging and speculating purposes.

Also Read: Introduction to Stock Market Trading

Real Example of Option Trading

• Call Option

For example, if an investor buys an option contract with a strike price of Rs. 100 and expiry date two months later. If the price of the underlying asset increases to Rs. 120, the option holder can buy it at the strike price, that is, Rs. 100. The difference between the strike price and the current market price is the profit.

• Put Option

For example, if an investor buys a put option with a strike price of Rs. 120 and an expiry date of two months. If the price of the underlying asset falls to Rs. 100, the option holder can still sell it at the strike price of Rs. 120. The difference between the strike price and the current market price is the profit made by the option holder.

Who Are the Participants in Option Trading?

• Buyer of an Option

Option buyers are the ones who buy the right to exercise the option trading contract by paying a premium.

• Seller of an Option

Option sellers are also known as writers of the option contract. They receive the premium amount paid by the buyer and have the right to sell the underlying asset. 

Option Trading Strategies | Maximise Your Ultimate Returns

Option trading offers a wide range of strategies for investors. They can tailor and implement these strategies as per their needs, risk appetite, and market situations. Some of the most common types of option trading strategies are:

• Covered Call Option Trading Strategies

The covered call is one of the most commonly used option trading strategies in the derivatives market. This strategy consists of selling a call option on a previously owned stock. The primary goal in this is to generate additional income by an increase in the stock price.

• Protective Put Option Trading Strategies

This strategy involves buying a put option to mitigate the risk caused by a decrease in the stock price. The objective of a protective put is to safeguard the stocks in the case of market downturns.

• Straddle Option Trading Strategies 

This strategy entails buying a call as well as a put option on the same underlying asset with a common strike price and expiry date. It is mostly used when it is difficult to predict the direction of the market dynamics.

Learn option trading strategies to fix your ideal returns, manage risks, and confidently navigate market volatility!

Profitability Scenarios in Option Trading

The three profitability scenarios in option trading are as follows:

• In-the-Money (ITM): This is a profitability scenario in option trading that would result in a profit if it is exercised.

• At-the-Money (ATM): This is a profitability scenario in which the strike price of the underlying asset is the same as its current market price. Thus, if the contract is executed, it will be a no-profit and no-loss situation.

• Out-of-the-Money (OTM): This is a profitability scenario in option trading that would not result in a profit if it is executed.

Benefits of Option Trading

By learning how to trade options and implementing various option trading strategies, option trading can prove to be a powerful financial tool for generating profits. Some of its benefits are:

• Cost-effectiveness 

Buying option contracts requires a lower amount of initial investment when compared to stock trading. Thus, it is a cost-effective option for investors with a lower amount of funds available.

• Hedging

Option trading strategies are often used for hedging purposes to minimise the risk caused by uncertain market conditions. This is possible as traders can learn how to trade options and protect their portfolios against extreme price fluctuations.

• Flexibility

Option traders have flexibility in deciding the strategies they want to incorporate depending on their goals and risk appetite. They may choose to adopt various option trading strategies  among covered call, protective put, or straddle. This flexibility allows them to hedge against market risk and speculate on the price fluctuations.

• Higher Probability of Profits 

Unlike stock trading which requires the financial landscape to follow an upward trend in order to be profitable for investors, option trading proves to be beneficial.

Investors participating in option trading have a higher probability of earning profits as they can benefit from both upward and downward market price movements. 

Ready to explore the benefits of option trading? Let Univest walk you through them!

Disadvantages of Option Trading

While learning how to trade options seems to be an attractive way to maximise profits, it is important to consider its disadvantages too. Some of them are listed below:

• Limited Validity

Option trading contracts have a fixed expiry date, which represents till which the contract remains valid. If the desired price movement or market trend takes longer than the expiry date, the contract will become void. This time-bound nature of the options contract adds to the risk, especially if the timing of the market is off.

• Potential For Losses 

If the overall financial landscape does not align with the contract holders’ interests, it will result in a total loss of premium paid. Since the premium is non-refundable, it exposes traders to adverse risks associated with option trading.

• Market Volatility

Option contracts are highly volatile as their price fluctuates with market uncertainties, time factors, and investor sentiments. Due to the possibility of loss of premium, conservative investors may avoid them due to the unpredictability. So, it is favorable only for investors with high levels of risk appetite.

• Complexity

Option trading for beginners can be very challenging as it requires an in-depth understanding of financial markets, including price movements and factors affecting market volatility. Novice traders might find it difficult to understand and implement the different option trading strategies like covered call, protective put, and straddle. 

Tips For Successful Option Trading in 2025

• Understanding the Basics Thoroughly

Before proceeding with option trading, it is essential to have a solid understanding of fundamentals involved. Due to the complex nature of option contracts, insufficient knowledge or misinformation can result in huge losses. Therefore, comprehending key concepts like call & put option, intrinsic value, option premium, etc. is crucial.

• Practicing Simple Strategies Initially

Beginners should always start their option trading journey with relatively safer and simple strategies. Complex strategies might seem more lucrative, but they come with their own set of risks and demand a good hold over fundamental concepts. After thoroughly practicing simple strategies, one can level-up to implement advanced online trading strategies.

• Risk Management Techniques

Effective risk management is one of the most significant factors in executing profitable option trades. Financial markets are exposed to adverse conditions that can lead to potential losses. To mitigate these uncertainties, proper risk management techniques should be implemented depending on the investors’ threshold.

• Prioritising Rational Decisions

Due to the limited validity of option contracts, investors might get triggered due to this pressure. These triggers can lead to strong emotions like greed or fear, further resulting in impatient loss-making decisions. To avoid this, it is vital for investors to make rational option trading strategies in the cases of market volatility and ensure well-informed decisions. 

• Staying Updated With Market Trends

Option contracts are highly vulnerable to fluctuations in the market trends. All relevant news regarding the economic landscape, financial developments, geopolitical factors, etc. have a strong impact on the market dynamics. Thus, it becomes imperative to stay updated with the factors affecting option trades. 

• Diversification

Relying on a particular sector or asset class can be risky if it underperforms. Therefore, one must incorporate various sectors to mitigate the risk. Additionally, diversification in terms of option trading strategies is equally important.

Conclusion

Option trading is a well-known financial tool that helps investors mitigate risk in a flexible and strategic way. Traders can maximise their returns by gaining thorough knowledge about option trading strategies. At the same time, one must keep the disadvantages and risks associated with option trading in consideration. Since price fluctuations are susceptible to market volatility, it is imperative to stay updated on financial market trends to ensure accurate predictions and rational decision-making. 

New to options trading? Download the Univest app now to get expert guidance!

Key Terms Used in Option Trading

To understand how to trade options, it is important to know the key terms that are used in option trading in the derivatives market. Some of them are:

• Strike price: Strike price is a preset and fixed price at which the option holder can choose to buy (in the case of a call option) or sell (in the case of a put option) the underlying asset. It is commonly referred to as the exercise price at which the buyer and seller enter the contract. 

• Premium: Premium is the cost to acquire the rights to exercise an option trading contract. It is paid by the option buyer and represents the upper limit of the potential losses. Moreover, it is an income for the option seller.

• Expiry date: Expiry date refers to the last date till which the option contract is valid. After this date, the contract will become invalid. So, it is mandatory for the buyers and sellers to exercise the option trading contract on or before the expiry date.

• American option: The type of option contracts which can be exercised at any time before the expiry date or on the expiry date are known as American options. 

• European option: European options refer to the type of option  contracts which can be exercised only on the expiry date. In Indian financial markets, only European option trading contracts are available.

• Underlying asset: The financial instrument on which the option trading contract is based is known as an underlying asset. These could include stocks, commodities, currencies, or indices.

• Intrinsic value: The variance in the strike price and the current market price of the underlying asset is known as intrinsic value.

• Time value: Time value refers to the portion of the option’s premium amount reflecting the time remaining until the expiry date of the contract.

• Hedging: Hedging is a popular risk-management strategy to minimise the risk of uncertainty.

FAQs on Option Trading

1. What is option trading?

Ans. Option trading is the buying and selling of option contracts tied to an underlying asset.

2. Is option trading for beginners too?

Ans. Option trading for beginners can be challenging. So, it is important to gather adequate knowledge and learn key strategies before beginning.

3. What is an option premium?

Ans. Option premium is the amount paid by the buyer of the contract in order to acquire the rights to exercise an option trading contract.

4. What are option trading strategies?

Ans. Some of the most common option trading strategies are covered call, protective put, and straddle.

5. Is option trading risky?

Ans. Yes, option trading is considered a high-risk investment as it is susceptible to market volatility.

Disclaimer: The above article is for informational and educational purposes only. The Securities quoted (if any) are for illustration only and are not recommendatory. Past performance does not guarantee any future returns. Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.

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