PCR Trading Strategies

Part 1: Introduction to Options

Options are a type of derivative instrument that derive their value from an underlying asset like stocks, indices, commodities, or currencies. Unlike buying the asset itself, options give you the right—but not the obligation—to buy or sell the asset at a predetermined price (strike price) before or on a specific date (expiration).

Key Points:

Options are contracts between two parties: the buyer (who has the right) and the seller/writer (who has the obligation).

They are flexible instruments used for hedging, speculation, and income generation.

Options can be American style (exercisable any time before expiry) or European style (exercisable only at expiry).

Why options are popular:

Leverage: Small investment can control large positions.

Risk Management: Can hedge existing positions.

Versatility: Can profit in bullish, bearish, or sideways markets.

Part 2: Types of Options

There are two primary types of options:

1. Call Option

Gives the buyer the right to buy an underlying asset at the strike price.

Buyers of calls profit when the asset price rises above the strike price plus premium paid.

Example: If a stock is at ₹100, and you buy a call with strike ₹105 for a premium of ₹5, you make money if stock > ₹110 (105 + 5) at expiry.

2. Put Option

Gives the buyer the right to sell an underlying asset at the strike price.

Buyers of puts profit when the asset price falls below the strike price minus premium paid.

Example: If a stock is at ₹100, and you buy a put with strike ₹95 for a premium of ₹3, you profit if stock < ₹92 (95 – 3) at expiry.

Part 3: Option Terminology

Understanding the language of options is crucial:

Strike Price (Exercise Price): Price at which the option can be exercised.

Premium: Price paid to buy the option.

Expiration Date: Date on which the option expires.

In-the-Money (ITM): Call: Stock > Strike, Put: Stock < Strike.

Out-of-the-Money (OTM): Call: Stock < Strike, Put: Stock > Strike.

At-the-Money (ATM): Stock ≈ Strike Price.

Intrinsic Value: Difference between current stock price and strike price (if profitable).

Time Value: Extra value reflecting remaining time until expiry.

Note: Premium = Intrinsic Value + Time Value

Part 4: How Options Work

Option trading revolves around buying and selling contracts. Let’s break down the process:

Buying a Call:

Expectation: Stock price will rise.

Profit: Stock price > Strike + Premium.

Loss: Limited to premium paid.

Buying a Put:

Expectation: Stock price will fall.

Profit: Stock price < Strike – Premium.

Loss: Limited to premium paid.

Writing (Selling) Options:

Involves taking obligation to buy/sell if the buyer exercises.

Generates premium income but comes with unlimited risk (especially for uncovered calls).

Exercise and Assignment:

Exercising: Buyer uses the right to buy/sell.

Assignment: Seller is notified they must fulfill the contract.