Part 4 Learn Institutional Trading

1. How Option Trading Works

Imagine two traders:

Rahul (Call buyer) thinks Infosys will go up.

Neha (Call seller) thinks Infosys will stay flat or fall.

Infosys spot = ₹1500. Rahul buys a Call option at 1520 strike for a premium of ₹20. Lot size = 100 shares.

If Infosys rises to ₹1600, Rahul gains (1600 – 1520 = ₹80 profit – ₹20 premium = ₹60 net profit per share × 100 = ₹6,000).

Neha loses ₹6,000.

If Infosys stays below 1520, Rahul’s option expires worthless, and his maximum loss is ₹2,000 (premium paid).

This shows how option trading is a zero-sum game: one’s profit is another’s loss.

2. Option Premium & Its Components

The premium you pay for an option has two parts:

Intrinsic Value (IV): Real profit if exercised now.

For Call = Spot Price – Strike Price.

For Put = Strike Price – Spot Price.

Time Value (TV): Extra value due to time left till expiry (uncertainty = potential).

As expiry nears, time value decays (Theta decay).

3. Moneyness in Options

Options are classified based on relation between spot price & strike price:

In the Money (ITM): Option has intrinsic value.

Example: Spot ₹1600, Call strike ₹1500 = ITM.

At the Money (ATM): Spot = Strike.

Example: Spot ₹1600, Call strike ₹1600.

Out of the Money (OTM): Option has no intrinsic value, only time value.

Example: Spot ₹1600, Call strike ₹1700.

4. Participants in Options Market

Hedgers – Reduce risk (e.g., an investor hedges stock portfolio with put options).

Speculators – Take directional bets for profit.

Arbitrageurs – Exploit price differences across markets.

Option Writers (Sellers) – Earn premium by selling options, often institutions.

5. Why Trade Options? Benefits & Uses

Leverage: Control large positions with small capital.

Hedging: Protect portfolio against adverse moves.

Flexibility: Multiple strategies for bullish, bearish, or neutral markets.

Income Generation: Selling options can provide steady income.

Risk Defined (for buyers): Maximum loss = premium paid.

6. Risks in Option Trading

Unlimited Loss (for sellers): Option writers can face huge losses.

Time Decay: Buyers lose money if market stays sideways.

Volatility Trap: Sudden volatility crush can wipe out premiums.

Complexity: Requires deep knowledge of Greeks & strategies.

Liquidity Risk: Some options have low trading volume.