Before we move to discuss the pros and cons of options trading it would be wise to know what options trading exactly is. If you’ve invested or traded in stocks, there’s a good chance that you must’ve heard of options trading in the stock market. But there’s also a good chance that you don’t understand what options trading exactly is. So, before we talk about the benefits and risks of trading options, why don’t we briefly talk about the options trading? At least, you should be able to develop a better understanding of the concept and can clearly understand the risks and benefits associated with it.
In the financial market, an option is a contract that gives you (owner) the right, but not the obligation, to buy or sell an underlying asset at a specific price before a specific date.
At least, that’s what we usually found on Google, whenever looking out to know what options’ trading really is.
Here, the underlying asset is the security/asset that the option contract allows you to buy or sell.
‘Specific Price’ is the strike price at which you can buy or sell a particular underlying asset or security under an option contract. And the specific time is the ‘Expiration Date’ at which the option expires.
Here a buyer pays a certain premium amount to the seller for this right. There are two types of options:
Call Option – Is a type of option that gives a person the right to buy the underlying asset, but not the obligation at a specific price.
Put Option – Is a type of option that gives a person the right to sell the underlying asset at a specific price. In short, it is just the opposite of the call option.
National Stock Exchange (NSE) & Bombay Stock Exchange (BSE) are the only two exchanges in India that are allowed to trade equity derivatives contracts. When someone invests in the share market in the equities, he/she gains the ownership in a corporation and the rights of ownership such as rights to vote on corporate matters, right to receive dividends, right to transfer, and right to do an inspection of corporation’s books and records, and among others.
However, in trading options, you won’t have the ownership in the corporation. In doing options trading, there are certain benefits and risks which are as follows:
Pros & Cons of Options Trading
Now that we’ve attained the basic knowledge on options trading now let’s move on to the pros and cons of trading options in India.
Options trading worked as strategic investment alternatives. One can convey different market opinions such as bearish, bullish, slightly bullish/bearish, as well as contracting and expanding volatility etc.
Options trading also popularized for “Limited Risk” despite there are times when trading options are riskier than investing in equities. But, it is because in trading options one requires very less finance as compared to equities. This is what reduces the overall risk of losing capital in trading options. In short, it depends on how you use them.
Options trading provide great leverage to the trader that when used properly; keep most of your capital free and provide a cost efficiency that won’t be like in the equities investing.
Most of all, options trading provide higher potential returns where you spend a very small amount aka premium and make huge profits; and a higher percentage of returns.
No doubt, the options trading have several benefits that one can have to make potential profits. But, there are some downfalls or should we say risks involved in trading options that are worth to look at.
For starters, the options’ trading is very complex. It means, to obtain potential profits, one needs to observe the trades consistently to go through the market’s ups and downs. Especially, for beginners who aren’t as skilled as professional traders to perform technical analysis in trading options. There are so many strategies to work on which require too much of time. So, beginner traders must be aware of implied volatility.
Higher spreads trouble many traders who do options trading. The options have higher spreads due to the lack of liquidity. Besides, there are so many indirect costs in trading options. Compared to equity investments, the investor in options trading pays more commissions for both sides because of high spreads.
Another drawback of trading options is, it is very difficult to get information such as quotes and analytics. On top of that unlike equities, there is a limit on trading in options since options are not available for all stocks listed on NSE & BSE.
Last but very important “Time Decay”. In buying options, many options buyers lose the value of an option due to time decay when closing to the expiry date. Thus, traders have to be more careful while trading options since with time the value of options fall consistently.
Overall, we can say that options trading provide a great opportunity for making good profits but one has to be well-informed and must be skilled to perform several technical analysis and implement options strategies.