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Options Made Easy: How to Make Profits Trading in Puts and Calls
At 30, Dhiraj decided that it was time to move from the basics of investing and try his hand at more complex asset categories like derivatives. A seasoned investor with 8 years of experience, Dhiraj had several positives on his side – as a young, employed professional with a monthly salary and sound investments, he could withstand a considerable amount of risk in the quest for high returns. Further, he had already diversified his portfolio into assets like equity, debt, gold and real estate. To boost his returns and learn a new skill, Dhiraj decided to pursue options trading and apply his market knowledge to this derivative sub-category.
To understand how to make profits trading in puts and calls, Dhiraj studied the market and realised that he could make profits by being an option buyer or an option writer. He could leverage option trades to realise potential during both volatile and stable market scenarios, if he made the right choice. He could earn returns as, inherently, the prices of assets keep moving, regardless of market conditions and options trading allows investors the possibility of realising gains in all market conditions.
Options Made Easy
If you understand the basic tenets of puts and calls in options trading, you can stand to make strong returns. Options offer you the right, but not the obligation, to buy or sell the underlying asset at the pre-decided price, on or before the pre-decided time. There are two aspects here – the put and call option – that you should be aware of. In the call option, the buyer has the right, but not the obligation, to go through with the trade while, in the put option, the seller has the right, but not the obligation, to sell the underlying asset at the pre-decided price.
When you sell an option contract, or exercise the put option, you can earn a profit from the premium collected. However, you should remember that there is a potential for unlimited downside so be careful if you are on the other end of a put option. On the other hand, when you exercise the call option, your potential upside can be unlimited. This option also allows you to lower your risk as the maximum amount you stand to lose is the cost of the premium. Based on the strategy you use, you can profit from a variety of market conditions such as bull, bear and sideways markets.
How to Make Profits Trading in Puts and Calls?
If you exercise the call option, you can earn a profit if the price of the underlying asset rises before the expiry date. Similarly, exercising the put option can allow you to make a profit if the price falls below the pre-decided price, at the time of execution. The amount of profit you stand to make is dependent upon the difference between the actual price of the stock at the time of maturity and the pre-decided strike price. If there is a huge gap, your profit can be unprecedented but for this, your understanding of the market must be exceptionally sound. Otherwise, you could end up losing a lot of wealth. Therefore, your option trading strategy should be aligned to your risk profile.
You can practice the following strategies to make profits trading in puts and calls:
- Buying a Call – A basic option strategy, buying a call limits your risk as the loss is limited to the premium paid to buy the call. Simultaneously, you have limitless potential for making a profit if your speculation ends up being correct.
- Buying a Put – Another low risk strategy which allows you to earn high returns if your bet works out before the date of expiry, buying a put can be considered a good alternative to short selling the underlying asset. You can also use this strategy to limit your potential losses if the market goes against your expectations.
- Options Spreads – In this strategy, you can combine options on the basis of spreads by buying one or more options to sell one or more different options. Here, the spreading will help offset the premium as the premium on the sell option will net off against the premium on the buy option. This strategy will also help you cap potential downside, albeit at the risk of capping the potential upside in the meantime. You can use options spreads to benefit from almost all possible price movements, but remember that the scope for profit is truncated.
Dhiraj wanted to trade options because he believed that his speculation could work wonders. He was also confident of leveraging puts and calls to minimise his downside and hedge the short positions he wanted to place. If you are similarly confident of your expertise and wish to benefit from the market volatility, you can use these different strategies to make profits trading in puts and calls.
Frequently Asked Questions
What are puts and calls in trading?
Puts and calls are types of options contracts. A call option gives the buyer the right, but not the obligation, to buy an asset at a specific price (known as the strike price) within a set period. A put option gives the buyer the right, but not the obligation, to sell an asset at a specific price within a set time.
How do puts and calls work in options trading?
Options allow traders to speculate on price movements. Calls are bought when expecting the asset price to rise, and puts are bought when expecting it to fall.
What is the difference between buying and selling options?
Buying options involves paying a premium for the right to trade, while selling (or writing) options involves receiving a premium but taking on the obligation to trade.
Are puts and calls suitable for beginner traders?
While options can offer high returns, they also involve higher risks. Beginners should start with basic strategies and gain knowledge before trading complex options.
What are the risks associated with puts and calls trading?
Risks include losing the premium paid if the option expires worthless and potentially unlimited losses when writing options.
Can puts and calls be used for hedging?
Yes, traders often use puts to hedge against potential losses in a declining market and calls to protect against missing out on potential gains in a rising market.
How is the premium for an options contract determined?
The premium depends on factors like the underlying asset’s price, strike price, time to expiration, and market volatility. Other factors, such as interest rates and dividends, may also influence the premium.
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