Options Trading Basics: A Beginner's Guide to F&O
Options are derivative contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price on or before a specific date. In India, equity options are traded on the NSE (and to a limited extent on BSE). The NSE Futures & Options (F&O) segment is one of the most active derivatives markets globally by volume. This guide covers the fundamentals every aspiring options trader should understand.
Call Options vs Put Options
There are two types of options:
Call Option:
- Gives the buyer the right to buy the underlying asset at the strike price
- Buyers of call options expect the price to go up
- The seller (writer) of the call is obligated to sell if the buyer exercises the option
- Gives the buyer the right to sell the underlying asset at the strike price
- Buyers of put options expect the price to go down
- The seller (writer) of the put is obligated to buy if the buyer exercises the option
- Weekly expiry - Every Thursday for Nifty and Bank Nifty options (SEBI reduced weekly expiries to one per exchange from November 2024)
- Monthly expiry - Last Thursday of every month for stock options and index options
- Call: Strike price is below the current market price (e.g., Nifty 23,500 CE when Nifty is at 24,000)
- Put: Strike price is above the current market price (e.g., Nifty 24,500 PE when Nifty is at 24,000)
- ITM options have intrinsic value
- Strike price is equal to or closest to the current market price
- Example: Nifty 24,000 CE or PE when Nifty is at 24,000
- ATM options have the highest time value
- Call: Strike price is above the current market price (e.g., Nifty 24,500 CE when Nifty is at 24,000)
- Put: Strike price is below the current market price (e.g., Nifty 23,500 PE when Nifty is at 24,000)
- OTM options have zero intrinsic value, only time value
- Intrinsic Value - The real, tangible value of an option if exercised today. Only ITM options have intrinsic value
- Time Value - The extra amount buyers pay for the possibility of the option becoming profitable before expiry. Time value decays as expiry approaches (known as Theta decay)
- Price of underlying - Higher price increases call premium, decreases put premium
- Strike price - Deeper ITM options cost more
- Time to expiry - More time means higher premium
- Volatility (India VIX) - Higher volatility increases premiums for both calls and puts
- Interest rates - Minor impact but affects pricing models
- Buy a call option when you expect the stock/index to rise
- Maximum loss: Premium paid
- Maximum profit: Unlimited (theoretically)
- Example: Buy Nifty 24,000 CE at Rs 200. Profit if Nifty closes above 24,200 at expiry
- Buy a put option when you expect the stock/index to fall
- Maximum loss: Premium paid
- Maximum profit: Substantial (if price falls to zero)
- Example: Buy Nifty 24,000 PE at Rs 180. Profit if Nifty closes below 23,820 at expiry
- You hold shares in your Demat account and sell a call option against them
- Generates regular premium income from your existing holdings
- Maximum profit is capped at the strike price plus premium received
- Example: Hold 250 shares of Reliance (lot size), sell 1 lot Reliance Call option at a strike above CMP
- You hold shares and buy a put option to protect against downside
- Acts as insurance for your portfolio
- Maximum loss is limited to the put premium paid
- Example: Hold Infosys shares, buy Infosys Put to protect during earnings season
- Minimum lot value raised to approximately Rs 15 lakh (effective November 2024)
- Weekly expiry rationalisation - Only one weekly expiry per exchange allowed (effective November 2024)
- Upfront margin - Full SPAN + exposure margin required for option sellers
- Peak margin reporting - Brokers check margins at random times during the day
- Options on expiry day - Higher margin requirements on expiry day to curb speculative trading
- Eligibility - Brokers must assess client suitability based on income and trading experience before activating F&O
- Time decay works against option buyers; your option loses value every day
- 93% of individual F&O traders in India incurred losses as per SEBI's January 2024 study
- Leverage is a double-edged sword - small price moves can cause large percentage losses
- Option selling carries theoretically unlimited risk and requires significant margin
- Liquidity risk - Deep OTM or illiquid stock options may have wide bid-ask spreads
- Call options give the right to buy; put options give the right to sell
- Option buyers have limited risk (premium paid) but option sellers face potentially unlimited risk
- ITM options have intrinsic value, OTM options only have time value that decays towards expiry
- Start with buying options (limited risk) before attempting option selling strategies
- SEBI has significantly tightened F&O regulations since 2024 to protect retail investors
- Never trade options with money you cannot afford to lose, and always use stop-losses
- Use SBI Securities' F&O platform after understanding margin requirements and risk management
Put Option:
Simple analogy: Think of a call option as a booking token for a flat. You pay a small amount (premium) to lock in the price. If flat prices rise, you exercise your right and buy at the lower locked-in price. If prices fall, you let the token expire and lose only the premium.
Key Options Terminology
Strike Price: The predetermined price at which the option can be exercised. For example, a Nifty 24,000 Call gives you the right to buy Nifty at 24,000.
Premium: The price you pay to buy an option. This is the maximum loss for the buyer and the maximum profit for the seller.
Expiry Date: The date on which the option contract expires. NSE offers:
Lot Size: The minimum quantity of the underlying asset per contract. For example, Nifty options have a lot size of 25 (revised periodically by NSE). Lot sizes for individual stock options vary by stock.
ITM, ATM, and OTM
Options are classified based on the relationship between the strike price and the current market price:
In-The-Money (ITM):
At-The-Money (ATM):
Out-of-The-Money (OTM):
How Options Are Priced
An option's premium consists of two components:
Premium = Intrinsic Value + Time Value
Factors affecting option premium:
Basic Options Strategies
1. Long Call (Bullish):
2. Long Put (Bearish):
3. Covered Call (Income Strategy):
4. Protective Put (Insurance):
SEBI's Regulations for F&O Trading
SEBI has tightened F&O regulations significantly. Key rules to know:
Risks of Options Trading
Options trading involves substantial risks: