Futures & Options
What are Futures & Options?
Futures and Options are derivative contracts1A derivative is a financial instrument that derives its value and performance from – the value and performance of another asset. which trade on the stock exchanges.
A future is a contract between two parties where one buys (and the other sells) the underlying asset at a predetermined future date (and time). Both the contracting parties are obliged to honour the transaction, irrespective of the price of the underlying asset at the time of delivery2the time on the predetermined future date as mentioned in futures contract . These contracts are settled in cash (i.e. money terms, not physical cash).
The stock future of TCS (Tata Consultancy Services) for the March 2018 expiry 3the date on which a futures contract is settled. In India, this date is the last Thursday of every month. In the case of the Bank Nifty index, there is a weekly expiry i.e. every thursday. closed at ₹ 3,054.50 on 12th March 2018. So if the trader buys (sells) the futures contract, on the date of expiry if the rate of TCS is more than ₹ 3054.50, the trader stands to make a profit (loss) for the difference, and if the rate of TCS is lesser than ₹ 3054.50 then the trader makes a loss (profit) equivalent to the difference. Trades in futures and options can only be made in multiples of the exchange defined lot sizes 4minimum number of units of a stock of which a trade entry is permissible . The lot size differs from one scrip to another.
An option is a privilege, sold by one party to another. This gives the buyer the right, but not the obligation, to buy or to sell the underlying asset (say stock, foreign exchange, commodity, index, interest rate etc.) at an agreed-upon price on a specific future date. The right to buy is called – Call Option. And the right to sell is called – Put Option. The price paid for the option is called option premium.
Who can invest?
Futures and Options are generally for shorter time horizons. Due to their high volatility and complexity, derivatives are recommended only for more sophisticated market participants.
But, this segment produces massive trading volumes, to a degree that – the volume of equity trades is only about 1-2% of the volume in Futures and Options. This implies that, if one knows what they’re doing, this segment is very rewarding.
Why does this segment exist?
This segment exists to enable market participants to –
- hedge their positions,
- trade away their portfolio risk without necessarily affecting their holding.
- Higher return for a relatively smaller investment.
- Owing to lower transaction costs, this segment more liquid, hence, information enters derivative markets quicker than in equity markets. Due to this, this segment enables better price discovery.
- Enables short selling. 5selling the security without owning it first, to benefit from future depreciation of price .
Since when has this segment existed?
This segment was started in India by both NSE and BSE in June 2000.
How can one be a successful F&O trader?
Someone aspiring to be an F&O trader must do some basic reading, without getting overwhelmed with too many academic concepts. They must understand concepts like – expiry, time decay, volatility, etc. A chat with someone with experience about this is invaluable. And finally, to sharpen one’s skill – learning by doing is always the best.
The NiSM certifications for derivatives segments is a good place to kick off your learning.
Where can I get started?
Though there are many good brokers in the market, we would be happy if you chose us. 🙂
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