LEARNING CENTER

WHY WOULD I CHOOSE STOCKS ?

Stocks are one of the most effective tools for building wealth, as stocks are a share of ownership of a company. You thus have great potential to receive monetary benefits when you own stock shares. Owning stocks of fundamentally strong companies simply lets your money work harder for you since they appreciate in value over a period of time while also offering rich dividends on a periodic basis.

WHY ARE INDICES IMPORTANT ?

Traditionally, indices have been used as information sources. By looking at an index we know how the market is faring. This information aspect also figures in myriad applications of stock market indices in economic research.

WHAT ARE THE FUTURE CONTRACT ?

A futures contract is an agreement between two parties – a buyer and a seller – wherein the former agrees to purchase from the latter, a fixed number of shares or an index at a specific time in the future for a pre-determined price. These details are agreed upon when the transaction takes place. As futures contracts are standardized in terms of expiry dates and contract sizes, they can be freely traded on exchanges. A buyer may not know the identity of the seller and vice versa. Further, every contract is guaranteed and honored by the stock exchange, or more precisely, the clearing house or the clearing corporation of the stock exchange, which is an agency designated to settle trades of investors on the stock exchanges.
Futures contracts are available on different kinds of assets – stocks, indices, commodities, currency pairs and so on. Here we will look at the two most common futures contracts – stock futures and index futures.

WHAT ARE OPTION CONTRACT ?

An ‘Option’ is a type of security that can be bought or sold at a specified price within a specified period of time, in exchange for a non-refundable upfront deposit. An options contract offers the buyer the right to buy, not the obligation to buy at the specified price or date. Options are a type of derivative product.
The right to sell a security is called a ‘Put Option’, while the right to buy is called the ‘Call Option’.
They can be used as:

  • Leverage: Options help you profit from changes in share prices without putting down the full price of the share. You get control over the shares without buying them outright.

  • Hedging : They can also be used to protect yourself from fluctuations in the price of a share and letting you buy or sell the shares at a pre-determined price for a specified period of time

Though they have their advantages, trading in options is more complex than trading in regular shares. It calls for a good understanding of trading and investment practices as well as constant monitoring of market fluctuations to protect against losses.

WHAT TYPE OF OPTION ?

At the basic level, there are 2 types of options:

  1. Call option (CE) – In simple terms, you buy call if bullish or sell call if bearish.

  2. Put option (PE) – Again simply put, you buy put if bearish or sell put if bullish.

 Based on option price w.r.t price of underlying stock/index, there are 3 types of options:

  1. OTM – Out of money options – e.g. if NIFTY is trading at 8317 currently, all CE’s above strike of 8300 i.e. 8400, 8500, 8600 etc are OTM options. Similarly all puts below 8300 are OTM.

  2. ATM – At the money – Options where strike price is same as price of underlying stock/index. e.g. Coal India is trading at about 340. So, 340 CE & PE are ATM options.

  3. ITM – In the money – These are CE’s where strike is below spot (spot is current price of underlying stock/index) or PE’s where strike is above spot e.g. all CE’s below 8400 are ITM.

WHY TRADE OPTION ?

One advantage of option trading as compared to stock trading is the amount of flexibility, you have lots of option strategies to make money in any kind of market –

  1. Stocks going up

  2. Stocks going down

  3. Stocks remaining stagnant or range bound

Another advantage is that your money is always liquid. This being a long term investment group, this may not be a consideration for people, but to make money from stocks, you need to block your capital for comparatively longer period of time.

Whereas, in options, mostly trades are held maximum till expiry of current month, which is last Thursday of every month. So, you make money without really blocking your capital.