Greetings! I am a new trader and had a doubt regarding Options Trading. Since the NIFTY 50 Index cannot be purchased like a stock, how can we purchase Option Contracts for it? According to Investopedia, " Options are a form of derivative contract that gives buyers of the contracts (the option holders) the right (but not the obligation) to buy or sell a security at a chosen price at some point in the future". So if I hold the option for NIFTY, I have the right to buy NIFTY 50. But as we all know, we can’t really buy NIFTY so what’s going on here? Thanks for reading this!
To go one level above investopedia definition,
options are not just meant to ‘acquire the right to buy or sell underlying’.
it also is meant to hedge your holdings.
so if i have invested in nifty50 etf or index fund, i can buy options to hedge my position.
also, if i have shorted/longed nifty50 futures, options can be used to hedge my positions.
You can buy the Niftybees. Which is an etf that moves in sync with nifty. It trades like a stock but actually is an index fund. Other than that there are index funds like uti nifty Index and axis nifty 100. We also have nifty futures for short term trading.
So there are many ways to buy nifty. Options are cash settled in index. The exchange doesn’t give you delivery of the index. They give you the amount of profit or loss you would have got if you had bought the index at the option strike and exited it at expiry date. Basically they settle it directly using cash. You can use the cash to buy niftybees if you want.
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Thanks for your reply. I got an understanding of why options exists for these Index funds. I wish to know the history as to how they first came into existence and what was the thought process behind it. If you have any article which talks about this topic then please let me know. Thank you so much!
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Thanks mate. It’s great to know how the settlement for these options take place for non tradable funds. It would be interesting to know how this idea came into existence. If you happen to have any article referring to that then please let me know. Thank You!
They came into existence from agriculture, and has been popularized by international trade (options on forex) and later on same principle is used by insurance companies.
For example,
I am peanut oil merchant, i buy peanuts from farmer, rent oil extractor and extract and sell oil.
(assuming i dont have my own oil extractor).
if there is a bumper harvest, renting oil extracting machine can become very costly because lot of peanuts available in market.
if there is a failed harvest, I could be renting oil extracting machine at lower cost than usual because there is abundance of machine renters.
As a oil merchant, the sensible option is, to pay an advance to a machine renter, before harvest happens, so that i am assured that, if harvest is big, i have a machine available to me assuredly.
the ‘advance’ i am paying is the premium for a call option.
if the machine rental value becomes so high that (higher than profit you will make from selling peanut oil), i will just sell the rights to the machine i rented to some other merchant instead of making oil myself. (this is equivalant to doing cash settlement instead of taking delivery).
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Thanks a lot pal. I now have a vivid understanding of how options work as flawlessly as they do, The example was amazing and it really helped a lot.
You can’t understand options in a day. Spend some time on zerodha varsity. Practice some paper trades on Opstra or Sensibull. Watch options behaviour on zerodha. Track straddle/strangle charts on tradingtick.com. You will slowly get the hang of it.
Whenever learning a new thing, we get an euphoric feeling early on that this is so easy and I have got it. Options are not so easy. They’re one of the most notorious things to trade. So take your time.
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Alrighty Mate. And thank you so much for mentioning these resources as well. I will check all of them one by one and practice and learn. Also, if you know some other websites or YouTube channels that I must be aware of then please let me know.