How to build a stock option trading strategy in India?

An option that has stock as its underlying asset is called a "stock option." There is another type of option that deals in the index, known as the "index option." The payoffs or risk-rewards that are appropriate for stock options are applicable in the case of other options as well as put options.

  • Stock options are a derivative where the underlying asset is a stock, such as RIL or SBI.
  • Stock options have respective sizes, different strike prices, and different times in which they must be executable.
  • Options are like futures, but unlike futures, the profits and losses in options are not linear depending on their upward or downward movement.
  • Moreover, all stocks are not allowed to be part of options and there are restrictive policies on stocks that tend to be part of an option.

European Types of Options

Indian markets primarily deal in European types of options which can be exercised only on maturity. This makes the market of options rigid and non-flexible. Although one may buy or sell options, the investor may face the heat of large losses if the market starts to fluctuate.

"Moneyness" is another point to check while making an options trading strategy in India. It is necessary to consider whether the option is in-the-money, at-the-money, or out-of-the-money while exercising it. There is no use of options if they have no intrinsic value or are exercised when there is no intrinsic value in them.

Trading stock options and building a stock trading strategy

Following are some of the important points to remember while trading stock options and building a stock trading strategy −

  • Determining the fair value of options− As the bid-ask spread of stock options is wide, it is hard to calculate the fair value of the options. For example, the price of the stock may be INR 1 and the asking rate may be INR 5. In such cases, determining the fair value is a tough task. It is recommended to take the help of a professional.
  • Illiquidity− Most of the options traded in India are illiquid and the depth in dealing with shares as underlying is shallow. It is hard to see recognizable deals in options in comparison to the stock or other derivative trading. Illiquidity may impact the trading strategies where the availability of illiquid assets creates huge losses.
  • Market orders− Availing market orders in Indian markets could be detrimental to one’s strategy. This is due to the illiquid nature of Indian markets where stock options are traded very minimally.

Updated on: 04-Oct-2021


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