Options Trading for a 5 Year Old Mansi Suryawanshi

Preface Options Trading is considered to be highly Technical and complicated. Unnecessarily it has been made so. I have tried my best to simplify this subject to such an extent that even a 5 year old kid could understand it. Please keep the things simple and let’s not confuse ourselves with complicated things. I have given ready-made Options strategies, please understand these thorouly and make money like professionals.

Options Trading for a 5-year-old Options means Choice. You get to choose. We all like to be given choices. Don’t we? Can same be applied while Trading Stocks? Suppose, Infosys is Trading at Rs.1750. This is the price at which the seller is willing to sell the stock. If I want to buy this stock, I will have to pay Rs.1750. If I want to buy the stock do I have the choice? No… Because no seller is available to sell the stock below this price (This is called Ask price). I have two choices now either to delay my buying and wait for a lower price… Or Buy at the ask price i.e. @ 1750. Regarding price I have no choice. Same applies for sell also.

I want to sell the Infosys stock. The highest bid (Bid means the highest price a buyer is willing to pay for the stock) is Rs.1750. I have no choice to sell at a higher price than that, because at this point no one is willing to buy at a price higher than that. I only have two choices: Either to sell at the current bid price… Or Delay the selling decision in a hope to get a higher price. Regarding price I have no choice. Sad, not so good, naa!!! I want to have a choice yaar. I want to be given a choice to Buy the stock, now, at a price I wish that is appropriate. And I want to be given a choice to Sell the stock, now, at a price I wish that is appropriate.

Great news for you!!! There is a mechanism in the stock Market that gives you this freedom of choice. This is called Options. An Option to BUY at a price, that I wish is appropriate.( CALL) Or An Option to SELL at a price, that I wish is appropriate. (PUT) Feels nice... I have an option to buy at a certain price. And I have an option to sell at a certain price. This option is valid for a certain duration of time. This is called Expiration date. If the Option is available for a Week, then it is called Weekly Options.

If the Option is available for a Month then it is called Monthly Options. Options are available for longer durations also. Call Option(An Option to Buy at a specified price within Expiration date). Every transaction has to have two parties A Buyer and A Seller. Also called the Writer of the Option. Hence for Call option also there is: Buyer of the Call Option and Seller of the Call Option. Let’s see Call Options buyer’s perspective. Call options are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity, or other asset or instrument at a specified price within a specific time period. ...

A call buyer profits when the underlying asset increases in price within a specified time limit (Expiration date). You buy the call option when you are Bullish and you hope that the price of the stock is going to increase within a specific time schedule. Let’s break the definition down: The call option buyer has the Right to buy the stock at a specified price and he is under no obligation to fulfill the Contract. The specified price that we are talking here is called the Strike Price. The Strike Prices are the choices we are talking about here. The Contract will be entered into for a specified Time frame called the Expiration date. It could be weekly, monthly or for a longer duration also.

Let’s understand this by an example. If Infosys is Trading a 1754. We call this as Spot price. In cash market, if I have to buy this stock, I will have to pay Rs.1754. However, Option gives me a choice. This choice is available a specified price interval. Strike Price

1670 1690 1710 1730 1750 1770 1790 1810 1830

Premium I

T M

O T M

72 46 31 16 7 5 3 2 1

(Buyer pays & Seller receives)

CALL Option ITM (In the Money) (A price less than ATM) ATM (At the Money) OTM (Out of the Money) (A price more than ATM)

The Call Strike Price which is nearest to the Spot Price is called ATM(At the Money).

The Call Strike Price which is less than the Spot Price and also the ATM is called ITM(In the Money). The Call Strike Price which is more than the Spot Price and also the ATM is called OTM (Out of the Money). If I choose the Strike Price 1750, I have chosen ATM call. If I choose the Strike Price less than1750 I have chosen ITM call. If I choose the Strike Price more than1750 I have chosen OTM call. As you remember, as a buyer of the Call Option I have the right to buy the stock at the strike price I have chosen. But, this contract is entered into for a specified period called the expiry date. I will exercise my call option, if at the expiry of the contract Spot price is more than my strike price. As a buyerthere is one good thing that I have no obligation to fulfill this Contract. Means if I am not

benefitting, I can walk away from the contract without honoring it. How nice it is… But, wait There is an element called the Premium which I as a call option buyer has to pay the premium to the Seller of the Call Option also called the Writer of the Call. This premium is the income of the call writer and the cost to the call buyer. Call writer is under obligation to fulfill the Contract if the Buyer chooses to exercise the Option. If the call buyer is benefitting, he will exercise the contract. If he is not benefitting from the contract he will walk away from the contract losing the premium ha has paid for the Contract. All he loses is the premium he has paid. That is the max loss the buyer can incur. Means his loss is limited to the extent of premium paid for the contract.

Whereas, the Seller of the call option is exposed to unlimited risk. All he receives is the premium that is paid by the Buyer. Call Buyer Pays the Premium

Loss is limited

Call Seller Receives the premium Loss is unlimited I will Buy the Call option if I am Bullish. I will sell the call option if I am neutral or Bearish.

Put Option (An Option to Sell at a specified price within Expiration date). Let’s see Put Options buyer’s perspective. Put options are financial contracts that give the option buyer the right, but not the obligation, to Sell a stock, bond, commodity, or other asset or instrument at a specified price within a specific time period. ... A Put buyer profits when the underlying stock/asset decreases in price within a specified time limit (Expiration date). You buy the Put option when you are Bearish and you hope that the price of the stock is going to fall within a specific time schedule. Let’s break the definition down: The Put option buyer has the Right to Sell the stock at a specified price and he is under no obligation to fulfill the Contract.

The specified price that we are talking here is called the Strike Price. The Strike Prices are the choices we are talking about here. The Contract will be entered into for a specified Time frame called the Expiration date. It could be weekly, monthly or for a longer duration also. Let’s understand this by an example. If Infosys is Trading a 1754. We call this as Spot price. In cash market, if I have to Sell this stock, I will have to Sell at Rs.1754. However, Option gives me a choice. This choice is available a specified price interval.

Put Option Strike Price

Premium

1670 1690 1710 1730 1750 1770 1790 1810 1830

1 O 2 T 3 M 5 7 16 I 31 T 46 M 72

(Buyer pays & Seller receives)

Put Option OTM (Out of the Money) (A price less than ATM) ATM (At the Money) ITM (In the Money) (A price more than ATM)

The Put Strike Price which is nearest to the Spot Price is called ATM (At the Money). Example : Spot price 1708 than ATM Put will be 1700 The Put Strike Price which is less than the Spot Price and also the ATM is called OTM (Out of the Money). Example: ATM Put 1700 then 1680, 1660 etc. will be OTM Put.

The Put Strike Price which is more than the Spot Price and also the ATM is called ITM (In the Money). If I choose the Strike Price 1750, I have chosen ATM Put. If I choose the Strike Price less than1750 I have chosen OTM Put. If I choose the Strike Price more than1750 I have chosen ITM Put. As you remember, as a buyer of the Put Option I have the right to Sell the stock at the strike price I have chosen. But, this contract is entered into for a specified period called the expiry date. I will exercise my Put option, if at the expiry of the contract Spot price is below my strike price. As a buyer there is one good thing that I have no obligation to fulfill this Contract. Means if I am not benefitting, I can walk away from the contract without honoring it. How nice it is…