How does options trading work?
The setup
A buyer pays a premium for an option, then sells it before expiry or holds it to expiry. Take an Index X call with a strike of 25,000. Its premium is ₹100 a unit, and one lot here is 50 units. That lot is an assumption to keep the maths easy. It is not the NIFTY or BANKNIFTY lot size. The premium paid is ₹100 × 50 = ₹5,000, before charges. For the buyer, that ₹5,000 is the most the option itself can lose.
How is profit or loss calculated on a call option?
The trade can end in two ways. Sell before expiry, and the result is the selling premium minus the buying premium, times the units. Sell at ₹120 and the gross profit is ₹20 × 50 = ₹1,000. Sell at ₹80 and it is a ₹1,000 loss. Hold to expiry instead, and the call is worth the amount the final index level is above 25,000, or zero. At 25,050 it is worth ₹50, so the buyer still loses ₹2,500.
What it means — and does not
Direction alone does not decide the result. The premium paid, the size of the move and the time it takes all matter. At expiry this call breaks even at 25,100, which is the strike plus the premium. A bought put breaks even at its strike minus its premium. An option can be in the money and still lose money. And a premium can fall while the index rises, because time value shrinks as expiry comes closer.
- Call value of one unit at expiry (₹)
- Premium paid: ₹100 · 100
An Index X 25,000 strike call bought for ₹100 a unit. The line is what one unit of the call is worth at expiry. Below 25,000 it is worth nothing. The dashed line is the ₹100 premium paid. The call only gets back what it cost where the line reaches the dashed line, at 25,100. At 25,050 it is in the money but worth ₹50, so the buyer loses ₹50 a unit, or ₹2,500 on 50 units, before charges.
Show the underlying data
| Index level at expiry | Call value of one unit at expiry (₹) |
|---|---|
| 24800 | 0 |
| 24900 | 0 |
| 25000 | 0 |
| 25050 | 50 |
| 25100 | 100 |
| 25200 | 200 |
| 25300 | 300 |
What this does not establish
The numbers here are assumed and leave out charges, so a real result would be lower. sizes and expiry dates change, so check the current contract before you use any number. A buyer can lose the premium plus charges, and no more. A seller is different. The seller receives the premium but can lose far more than it, and must keep , which is not a loss limit. Stock options are different too. NSE stock options settle by delivery of shares, so this index example does not apply to them.
Things to check
6Which index or share is the option based on?
Is it a call or a put, and what are its strike and expiry?
What is the premium for one unit, and what is the current lot size?
What is premium × lot size, the full amount a buyer pays?
Are you buying, or selling something you do not own? The risks are very different.
How far, and how fast, must the index move to cover the premium and the charges?
Common mistakes
5Reading the premium as the price of one lot. It is the price of one unit.
Thinking "in the money" means "in profit". At 25,050 this call is in the money and still loses ₹2,500.
Believing a cheap option is a safe one. The whole premium can still be lost.
Expecting the premium to move point for point with the index.
Buying a put to close a call. It opens a second position. Closing a call needs a sale of the same call.
A 25,000 strike call bought for ₹100 a unit ends with the index at 25,060. What is the result on 50 units, before charges?
- A profit, because the call ended in the money
- A ₹3,000 profit, because 60 points × 50 units
- A ₹2,000 loss, because the call is worth only ₹60 of the ₹100 that was paid for it
Show the answer
C. A ₹2,000 loss, because the call is worth only ₹60 of the ₹100 that was paid for it
At expiry the call is worth 25,060 − 25,000 = ₹60 a unit. The buyer paid ₹100, so the result is (₹60 − ₹100) × 50 = −₹2,000. The first answer is tempting because "in the money" sounds like profit. It only means the call is worth more than zero.
Frequently asked
4Is buying an option the same as buying shares?
No. An option is a contract with an expiry date and a fixed set of rights. An index option does not make you the owner of any shares.
Do I have to hold an option until expiry?
No. You can usually close it earlier by selling the same contract, as long as a buyer is there. The result is then worked out from your two prices.
Are low premium options safer?
No. A small premium means you pay less for the same units. But the whole premium can still be lost, and a low price says nothing about the chance of a profit.
Why do so many beginners lose money in options?
SEBI's study of individual traders in futures and options found that most of them lost money. Charges, time decay and moves that are too small all add up. Learning what each trade can lose, and practising first, is the place to start.