What is Option Buying? A Guide For Traders and Investors

Option buying is one of the most popular methods for participating in the derivatives market. It allows traders to potentially benefit from market movements while risking only the premium paid to the option seller.

Compared with buying stocks directly, buying options requires less capital and may provide exposure to both rising and falling markets.

With the increasing popularity of option trading in India, more investors are exploring F&O trading to trade derivatives and hedge existing portfolios.

This detailed guide will explain what option buying is, how it works, its types, strategies, and benefits, associated risks and more.

What is Option Buying?

Option buying is a trading strategy where a trader purchases an option contract by paying a premium. The buyer receives the right, but not the obligation, to buy or sell the underlying asset at a predetermined price before or on the expiry date.

Unlike futures contracts, option buying does not force traders to execute the trade. If the market moves in the direction anticipated by the buyer, the buyer may choose to exercise the option or square off the position before expiry, depending on the contract type and market conditions.

If the market moves in the opposite direction to the buyer’s expectations, the buyer may choose not to exercise the option, and the loss is limited to the premium paid.

In option buying, two parties are involved: the option buyer and the option seller. The call option buyer transacts with the call option seller. Similarly, the put option buyer transacts with the put option seller.

A call option buyer expects the price of the underlying asset to move up. In contrast, a put option buyer expects the price of the underlying asset to decline.

Note: There is no transaction between the call buyer and put seller.

Also Read: What is Option Selling?

How Does Option Buying Work?

The working mechanism of option buying is simple. Option contracts traded on exchanges are standardised, and transactions take place through the exchange.

Every option contract has a buyer and a seller. The option buyer pays a premium to the seller in exchange for certain rights.

Example:

Nifty spot is trading at 24,000. One lot = 65 units of shares

A trader expects Nifty to rise over the next week. The trader buys one lot of a Nifty 24,000 call option (CE) by paying a premium of ₹120.

If Nifty rises to 24,200, the trader earns a profit of 80 points x 65 units = ₹5,200.

Here,

24200 - 24000 = 200 points. 200 - 120 ( premium paid) = 80 points

On a net basis, the trader gains 80 points after deducting the premium.

If Nifty remains at 24,000 or falls below 24,000, the trader loses the premium paid.

The breakeven point for this trade is 24,120. At this point, the trader would neither make a profit nor incur a loss, excluding transaction costs, statutory levies and taxes.

The exchange provides an option chain that displays summarised information related to strike price, open interest, premium, and implied volatility. When trading options, it's important to analyse option chain data alongside technical or fundamental analysis and follow appropriate risk management practices.

Types of Option Buying

There are two primary types of option buying in the derivatives market: call option buying and put option buying.

Call Option Buying

Call buying means purchasing a call option when a trader expects the price of the underlying asset to increase. The buyer gains the right to purchase the underlying asset at a strike price before or on the expiry date.

Example:

XYZ stock is trading at ₹1600.

A trader believes that the stock will move to ₹1700.

The trader buys a ₹1,620 call option (CE) by paying a premium of ₹25.

If the stock reaches ₹1,700, the value of the option premium may increase from ₹25 to ₹100, depending on factors such as time to expiry and implied volatility. Assuming it rises to ₹100, the trader can sell the option and book a profit of 75 points.

However, if the stock price remains at ₹1,600 or slips below ₹1,600, the loss is limited to the premium paid.

Put Option Buying

Put buying means purchasing a put option when the trader expects the price of the underlying asset to decline. The buyer receives the right to sell the underlying asset at a strike price before or on the expiry date.

Example:

XYZ stock is trading at ₹1,600.

A trader believes that the stock price will decline to ₹1,500.

The trader buys a ₹1,580 put option (PE) by paying a premium of ₹25.

If the stock declines to ₹1,500, the value of the option may increase from ₹25 to ₹100, depending on factors such as time to expiry and implied volatility. Assuming it rises to ₹100, the trader can sell the option and book a profit of 75 points.

However, if the stock price remains at ₹1,600 or rises above ₹1,600, the loss is limited to the premium paid.

Difference Between Option Buying vs Option Selling

Here is the difference between option buying and option selling:

How To Start Option Buying?

The process of starting option buying begins with opening a trading and Demat account with a SEBI-registered stockbroker.

• Activate F&O Segment:

After completing the account opening process, activate the F&O trading segment by submitting income proof or meeting the eligibility requirements prescribed by the broker and applicable regulations.

• Add Funds:

Add funds to your trading account. If your goal is to buy options, you do not need to pay margins beyond the premium payable, although you should maintain sufficient funds for premiums, charges and applicable taxes.

• Learn Option Trading Concepts:

Before starting to trade, learn the basics of option trading and concepts such as strike price, premium, expiry, intrinsic value, open interest, and implied volatility.

• Select Underlying Asset:

Choose a liquid stock or index with sufficient trading volume and narrow bid-ask spreads for better execution quality.

• Analyse Market Trend:

Use technical analysis, price action, indicators, and market sentiment to analyse market conditions.

• Choose Expiry and Study Option Chain:

Choose an appropriate expiry and study the option chain data such as open interest, implied volatility, change in OI, etc.

• Choose Appropriate Strike Price:

Select in-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM) options according to your market view and risk tolerance.

• Buy Option Contract:

According to your market view, place a buy order through your broker’s trading platform and pay the required premium amount.

• Set Stop-loss and target:

Some traders choose to set a stop-loss for risk management and decide on a target level. If the trade moves in their favour, they may choose to trail the stop-loss based on their trading plan.

If the trade moves in the opposite direction, the position may be exited according to the predefined risk management plan. The position may be exited according to the predefined risk management plan.

You can book profits or exit the trade anytime during market hours before or at the expiry date. There is no mandatory rule to hold the trade till the expiry date.

Popular Option Buying Strategies

Option buying strategies help traders take positions under different market conditions while managing risk. Here are some popular option buying strategies used by traders:

Protective Put

A protective put is a hedging strategy where an investor buys a put option while already holding the underlying stock in the portfolio. This strategy is intended to help reduce the impact of a sharp fall in the stock price.

In this strategy, the investor owns the stock and purchases a put option with a suitable strike price. If the stock price declines, the gain in the put option position may help offset the loss in the stock portfolio.

Long Straddle

In a long straddle strategy, a trader buys both a call option and a put option with the same strike price and the same expiry date.

A trader purchases one at-the- money (ATM) call option and one ATM put option simultaneously. If the market moves sharply in either direction, one option may generate sufficient gains to offset the cost of both premiums and potentially result in a net gain.

This strategy is suitable when the trader expects a major movement but is uncertain about the direction.

Long Strangle

A long strangle is similar to a long straddle but uses out-of-the-money (OTM) call and put options instead of ATM options.

In this strategy, a trader buys one OTM call option and one OTM put option with the same expiry. The lower premium reduces the initial investment, but the market must move significantly beyond either strike price before expiry for the strategy to become profitable.

Bull Call Spread

A bull call spread is a bullish option strategy created by buying one call option and simultaneously selling another higher strike call option of the same expiry.

In simple terms, traders buy a lower-strike call option and sell a higher-strike OTM call option. The premium received from selling the higher strike call partially offsets the cost of buying the lower strike call.

A bull call spread is used when a trader expects a moderate upward move rather than a sharp rally and wants to reduce the cost of establishing the bullish options position.

Also Read: What is Put-Call Ratio?

Best Market Scenarios for Option Buying

Here are some market conditions in which traders may consider option buying. The outcome of any trade depends on multiple market factors and cannot be guaranteed.

• One-Sided Directional Move

When the market is expected to rise sharply, traders may choose call buying to participate in the upward move. Similarly, when traders expect the market to fall sharply, they may choose to buy put options to monetise the downward move.

A strong one-sided bullish or bearish market may provide opportunities for option buying.

• Breakout Trading

When a stock or index breaks above resistance or below support with strong volume, option buying may be used to participate in the resulting momentum, subject to market conditions.

• High Volatility Events

Major events such as the Union Budget, RBI monetary policy announcements, election results, or quarterly earnings can lead to large price swings. However, option premiums may either rise or fall depending on implied volatility, market expectations and time to expiry.

• Trend Continuation

If the existing uptrend or downtrend is likely to continue, option buying allows traders to participate in the trend. However, risk management remains important throughout the trade.

• Reversal Trading

Option buying may be considered when technical indicators suggest the possibility of a reversal from important support or resistance levels.

• Gap-Up or Gap-Down Opening

Large opening gaps after important news may create strong intraday momentum. Some traders use option buying strategies in such market conditions.

When Should You Avoid Option Buying?

Here are some scenarios where option buying may be less suitable:

• Range-Bound Market:

Option premiums may lose value due to time decay when prices move sideways.

• Low Volatility Market:

Small price movements may not be sufficient to offset premium costs.

• Near Expiry Without Momentum:

Rapid time decay can significantly reduce option premiums.

• High Implied Volatility:

Expensive premiums may decline in value due to a fall in implied volatility, even if the underlying asset moves in the expected direction.

• Uncertain Market Direction:

Buying options without a clear trend may increase the likelihood of premium erosion.

Benefits of Option Buying

Here are the benefits of option buying:

• Limited Risk:

The maximum possible loss is generally restricted to the premium paid, making option buying comparatively less risky than naked option selling.

• Low Capital:

Traders can participate in the market by paying the option premium instead of the full value of the underlying contract.

• High Return Potential:

Strong directional market movements may generate significant percentage returns compared with the initial premium invested, although losses are also possible.

• Portfolio Hedging:

Investors may use put options to help protect existing equity holdings against adverse price movements.

• Trading Flexibility:

Option buying allows traders to take positions in bullish, bearish, and volatile markets using different option trading strategies.

Risk Involved in Options Buying

Here are the risks involved in option buying:

• Time Decay:

Option premiums gradually decline as expiry approaches, reducing the option’s value even without adverse market movement.

• Volatility Changes:

Falling implied volatility may reduce option premiums despite the underlying asset moving in the expected direction.

• Complete Premium Loss:

If options expire out-of-the-money, buyers lose the entire premium invested in the option contract.

• Wrong Market Direction:

Incorrect prediction about price movement may result in a decline in the option's value and possible trading losses before expiry.

• Emotional Trading:

Lack of discipline and frequent speculative trades may lead to consistent losses despite having sound trading knowledge.

Who Should Consider Option Buying?

Here are the types of market participants who may consider option buying:

• Beginners:

New traders seeking limited-risk exposure to derivatives may begin by learning option trading through disciplined option buying strategies.

• Directional Traders:

Traders with a bullish or bearish market view may consider buying suitable call or put options.

• Portfolio Investors:

Long-term investors may use put options as a hedging tool to help protect stock portfolios against temporary market corrections and volatility.

• Event-Based Traders:

Traders expecting major price movement during earnings, RBI policy announcements, or economic events often consider option buying positions.

FAQs

What is option buying in the share market?

Option buying is the process of purchasing a call or put option by paying a premium. It gives the buyer the right, but not the obligation, to buy or sell the underlying asset before or on expiry.

What is the difference between call buying and put buying?

Call buying is suitable when a trader expects the market or a stock price to rise. Put buying is used when a trader expects the market or a stock price to fall.

Is option buying better than option selling?

Option buying offers limited risk because the maximum loss is restricted to the premium paid. Option selling can generate regular income but usually involves higher risk and margin requirements. Neither approach is inherently better; the choice depends on the trader's objectives, market view and risk tolerance.

How much money is required for option buying?

The capital required depends on the option premium and lot size. Many index options can be bought with a relatively small premium outlay, making option buying accessible to eligible retail traders.

How does the option chain help in option buying?

The option chain provides information about strike prices, premiums, open interest, trading volume, and implied volatility. Traders use this data to analyse market activity and identify potential trading opportunities.

What is the maximum loss in option buying?

The maximum possible loss in option buying is limited to the premium paid for purchasing the option contract, excluding applicable brokerage, taxes and other transaction charges.