Understand Futures And Options Trading
Options and Futures are two key forms of stock derivatives whose trading is carried out in a stock market. In simple terms, they are a contract between two parties who want to trade in a stock asset at a specified date for an agreed price. Options and Futures (F&O) are used by investors who want to be safe from stock market risks. As the price for these contracts is agreed upon in advance, the parties can reduce the chances of losses due to price changes in the derivatives market.
In derivates trading, options and futures are contracts whose value comes from an underlying asset. This asset can be commodities, equity shares, ETFs, etc. F&O offers both parties, buyer and seller, a chance to reduce the future risk of their investment. As the price, in this case, is decided in advance, the risk is low. Though it is not easy to predict price changes in the future, any mistakes can lead to huge losses in the derivatives market. This is why only those parties with deep knowledge of the derivatives market choose to trade in Options and Futures.
What are the Options?
Options are derivatives linked to the value of an underlying asset, like stocks or commodities. With this contract, you can sell or buy the asset at a given price. This derivatives trading can take place only when the contract is valid. While you have the right, you also have the choice not to use the options on the given date. The price of the option is known as the “premium.”
In the derivatives market, you cannot own the underlying asset or obtain shareholder rights unless you exercise the option on a specific date. This derivative contract gives the buyer the right to buy or sell the asset at the given strike price. This right, however, must be exercised before the contract expires.
There are two options for derivatives trading in India: put options and call options. You can sell the stock at a given price with the put option. With the call option, you get the right to purchase the asset at the strike price.
What are Futures?
In derivatives trading, futures refer to a contract that makes it your duty to sell or buy an asset at a given price on a specific date. They are regarded as a true hedge investment. Here, the buyer wants to lock in a price to be safe against any price rises, and the seller wants to lock in a price to be safe against any price falls.
These contracts protect sellers and buyers from wide price swings in the derivatives market. Many retail investors also engage in futures trading to make profits from any changes in asset prices. In most cases, investors do not want to get the asset and settle the contract. Instead, they prefer to sell their position much before the due date.
Difference between Options and Futures
Options and futures might sound similar, but there are some differences between these derivative contracts. Here are some of the main differences: –
- Nature: In the case of futures, the trade must be completed on the given date per the commitment. Though options give you the right to complete the trade, there is no obligation.
- Date: In the case of futures, the trade for the underlying asset must occur on the given date. Though, in the case of options, you have the right to complete the trade until the contract is valid. In India, there are some variations in the rules. Here, a stock option can be completed until the last date of the contract, while an index options trade can be finalized only on the last date.
- Risk: In the case of options, you can choose not to enforce the trade in the derivatives market if there is a major price drop. For futures, you do not have this option, and the trade will take place regardless of the price, as the price has no bearing on your duty to complete the transaction.
- Payment: You do not need to make any advance payment for a futures contract under derivatives trading. The payment must be made on the specified date when the trade is to be completed. In the case of futures, you will need to pay a premium while placing an order. This will give you leverage, which can greatly impact your profits or losses. The premium will go to the seller if you do not complete the options trade.
Investing in Options and Future
There is no need for a Demat account for derivates trading options and futures. A simple brokerage account is all that you need. A registered broker can help you open this account. Here are some key facts related to trading in the derivatives market.
- Stock Market: In India, the BSE and NSE offer the facility of trading options and futures. Here, futures move more quickly than options due to the leverage available. The futures contract here is valid for three months. For most F&O transactions, you do not need to pay the full value of the asset. You need to pay the difference between the market price and the agreed price in the contract.
- Commodities: Commodities exchanges like MCX and NCDEX offer the facility of options and futures. These markets see rapid price changes, which are suitable for derivatives trading. Here, options and futures allow you to hedge against the risk of a price fall. This derivatives market is meant for seasoned investors, as new traders might find it difficult to analyze.
Options and futures are popular derivatives in India. Many investors trade in these contracts to make profits. But you should first gather all the details on derivatives trading before investing. Are you looking for similar finance blogs? Visit the Piramal Finance website and equip yourself with the knowledge of wide-ranging financial products and services, especially stock market trading, credit cards, and personal loans.
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