If you are looking into the simplest options for trading, then the buying and selling of options contracts in the F & O market are perfect for you. The process involves two parties mostly - the option buyer and the option writer. Realistically the writer of the option assumes more risks, so he receives a premium that the buyer is required to pay. 

There are two options - call and put. So, let's understand what options trading is, the call options and the put options, as well as the entire process flow for each. 

What is Options Trading?

Options trading is the practice of selling and buying options on respective exchanges. When you buy any option, you own the right to buy or sell the asset, depending on the option you have traded. For example, if you buy a call option, it means that you have purchased the right to buy the underlying asset as well. Also, when you buy a put option, you purchase the right to sell the asset. 

Options trading involves the trading rights to sell and buy all underlying assets. Since the options are financial instruments, they can be traded just like how other securities are. If you are beginning options trading, there are several options trading concepts, such as call options and put options.

What is a Call Option?

Call options are financial contracts that provide option buyers the right to buy a stock, commodity, bond, or other assets and instruments with a specific price within a specific time. The stocks, commodities, or bonds are the underlying asset. A call buyer makes profits when the prices of the underlying asset increase. 

Features of Call Option

Call options give the owner the right but not the obligation to buy specific amounts of underlying security within a specific price and time.

• The specific price is called the strike price, and the specific time in which the sale can be made is known as the time to maturity.
• When you purchase a call option, you pay a premium, and this is the maximum you can lose on a call option.
• Call options are purchased for speculation or sold for tax management. 
• Call options are combined for strategies.

Factors that Affect Call Options

1. The Strike Price - The strike price of a call option plays a major role in determining the value of the option. The lower your strike price, the more valuable your option becomes. This is because your underlying stock may go above the low price and then hit the higher strike price. As your call option only earns money if the stock prices are above the strike price, a low strike price makes your call option more valuable. 

2. Expiration time - The value of your call option is dependent on the expiration time. The longer your option contract has before it expires, the more valuable it is. A longer time creates a better opportunity for your stock prices to hit the best strike price. If there is enough time for the market to swing, then your call options become valuable. 

3. Volatility - If your stock price is volatile, then there will be large changes in the cost. The more volatile your stock, the more precious stock becomes. It only needs to hit above your strike price once for you to make money.

Examples of Call Options

Let's take an example to understand call options. 

Suppose Microsoft stocks are trading at $100 per share, and you own 100 shares. But you want to generate income that is above the stock's dividend. You speculate that the shares will rise to $115 per share in the next month. 

So, your call options for the next month will see 115-call trading at 40 cents per contract. So, you can sell one call option and collect a $40 premium (40 cents X 100 shares). This represents a 4% annual income. 

If your stock rises above $115, then the option buyer will get the option, and you can deliver the 100 shares at $115 per share. 

How do Call Options Work?

Call options are a derivative contract that offers holders the right but not the obligation to purchase a specific number of shares that are at a predetermined price called 'strike price.' If the market price of the stock rises above this price, then the option holder can use their option and buy at the strike price while selling at the higher price to get a profit. But these options last for a limited time, and if the price does not rise above the strike price, the options expire.

Why Should you Buy a Call Option?

There are mixed reviews about call options. Some investors call them optimistic approaches, while others think they are a waste of time. For positive investors, call options are an attractive way to speculate on the market and understand whether the company is a viable option for them to invest in. 

Is buying a Call Option Bearish or Bullish?

Buying call options is bullish because the buyer only gets a profit when the share prices increase. Conversely, selling call options is bearish because the seller's profits do not increase if the share prices do not rise. 

What are Put Options?

A Put Option, on the other hand, is a contract providing buyers the right, but not an obligation, to sell a specific amount of underlying security at predetermined prices within a specific timeline. This predetermined price where buyers add the put option and sell their security is called the strike price. 

Put options can be for stocks, bonds, currencies, commodities, indexes, and futures. A put option is contrasted with a Call Option as it gives the holder the right to buy the underlying security at the strike price before or on the expiry date of the contract.

Features of Put Options

• Put options offer holders the option of selling a specific amount of the underlying security at a specific price within the right time frame. 
• Put options are available for multiple assets that include stocks, currencies, commodities, and indexes 
• Put options are often impacted by any price changes of the underlying assets, such as time decay, option strike price, volatility, and interest rates 
• The options increase in value as the underlying asset price increases and the volatility of the underlying asset cost decreases.

Factors that Affect Put Options

1. Underlying Prices - Underlying prices are the spot price of the underlying asset of the derivative. If your underlying price increases, then your put price will decrease, and vice versa. 

2. Interest Rates - When considering interest rates, if it rises, then the put option price will decrease, and if it falls, then your put options price will increase. 

3. Dividends - Dividends and Put options are directly proportionate to one another. If the dividend rate rises, then your put price will increase, and if it falls, the rate will decrease.

Example of Put Option

Let's assume that an investor buys a single put option that was trading at $445, with a strike price of $425 that expires in a month. This trades at a minimum of $10, which is the intrinsic value of the put option. In this case, the investor paid a premium of $2.80 per share. 

If the unit falls to $415 before the expiration date, then the $425 put will be 'in the money, and the trade at a minimum of $10. The exact cost for the put option will depend on several factors, the most important being the expiration time. 

As the put option is now 'in the money phase, the investor has two choices: 

• Exercise the option, which confers the right to sell the 100 shares at a $425 strike price, or 
• Sell the put option and enjoy the profits. 

If the investor uses the put option, then the net profit in the trade is calculated as: 

[(Stock Selling Price - Purchase Price) - (Put Purchase Price)] X Number of shares 

= [($425 - $400) - $2.80] X 100 = $2220 

But what if the investor does not own the units, and the put option was a part of a speculative trade? In that case, the exercising put option results in a short sale of 100 units at the strike price of $425. Investors can buy back the 100 shares at the current price of $415 and close the short option. 

Then, the net profit would be calculated as: 

= [(Short Sell Price - Purchase Price) - (Put Purchase Price)} X Number of units 
= [($425 - $415) - $2.80)] X 100 
= $720 

But, this seems like a highly complex option, not to mention the added commission costs. But there is an easier option - sell the put option at the current price and make a nice profit. 

= [Put sell price - put purchase price] X Number of shares 
= [$10.50 - $2.80] X 100 
= $770 

Is Buying a Put Option Similar to Short Selling Stock?

Short selling and buying puts are both bearish options, but there is a major difference between the two. A put buyer's loss is limited to the premium for the put, but buying puts does not need a margin account and is done with limited capital amounts. On the other hand, short selling theoretically has unlimited risks and is more expensive due to costs such as stock borrowing charges. So, short selling is much riskier than buying puts. 

Should you buy 'In The Money (ITM) or 'Out of the Money' (OTM) Puts?

Your buying depends on multiple factors, such as the objective of trading, risks of appetite, and capital amount. The dollar outlay for ITM puts is higher than for OTM as you get the right to sell the underlying security option at higher rates. But, lower costs for OTM puts get offset by the fact that they are not profitable. If you are willing to accept the risk involved, then OTM puts are perfect for you, but if you want to invest in puts that offer better returns, then ITM is the way to go. 

Conclusion

Now that you know the basic differences between the call and put option, you can start looking at different companies that issue stocks and try to understand where your financial strategy stands. With the calculations provided, you can also understand the payoffs you will receive with each when trading in the stock exchange.