Option Trading: Basic Understanding

How Options Work

Each option represents a contract between a buyer and a seller. The buyer pays a premium to the seller (also called the writer) in exchange for certain rights:

The call option buyer has the right to buy the asset at the strike price.

The put option buyer has the right to sell the asset at the strike price.

If the market moves in favor of the buyer, they can exercise the option to make a profit. If the market moves against them, they can simply let the option expire, losing only the premium paid.

Example:

Suppose a trader buys a call option on ABC Ltd. with a strike price of ₹100, expiring in one month, for a premium of ₹5.

If ABC’s price rises to ₹120, the trader can buy the stock at ₹100 and sell it at ₹120, making ₹20 profit minus the ₹5 premium = ₹15 net profit.

If ABC’s price stays below ₹100, the trader will let the option expire and lose only the ₹5 premium.

This limited loss and unlimited profit potential make call options attractive for bullish traders.