Futures and Options (F&O)

Futures & Options (F&O) comprise the derivative trading in the share market. These contracts are signed by two parties for trading an asset on a later date, at a predetermined price.

In an options contract, the option buyer has the right (but no obligation) to buy or sell stock at a certain price on the predetermined date, called the Expiry Date.

On the other hand, in the futures contract, the contract holder has to buy or sell shares on a certain date in the future.

F&O are contracts that derive their price from the underlying assets such as shares, indices, commodities, etc. The markets for F&O are quite distinct in the way they work and the risk associated. A major volume of trading in the Indian Stock market happens in the Options segment.

Difference between Futures and Options

F&O both are different in terms of obligations.

Futures contracts obligate the investors to either buy or sell stocks on a future date at a predetermined price. Investors often get involved in futures contracts to hedge against asset price changes.

Options contracts on the other hand are also financial contracts, but not obligatory. They offer versatility and are used in forming various strategies for trading. It gives a range of prices that can be locked for transactions on a future date.

Let’s understand Future Contract vs Option Contract

Future Contact SECONDARY MARKET
Contract holders are obligated to honour the contract on the expiry date. Buyers of Option are not obligated to buy or sell the underlying asset on the expiry date
Both buying and selling of Futures contract requires higher margin payment however it is not the same case in Options Buying an Options contract attracts only the premium amount. The selling of Options attracts higher margins.
A trader willing to take a position in a Futures contract does not have the range of strike prices, which is the price at which underlying asset can be bought or sold on a Future date A trader in Option can select from a range of strike prices before entering the contract

Types of Futures and Options

Futures are fundamentally uniform with the same set of rules for both- “buyers and sellers”. On the other hand, Options can be divided into two types:

  • Call Option: It allows you to buy the underlying asset at an agreed price at a predetermined date.
  • Put Option: It allows you to sell the asset at a specified price on a predetermined date.

In both cases, the trade is optional. If the prices do not suit you then, you can choose not to utilize your call or put option.

Additional Read : Demat Account Opening Charges

Who Should Invest in Futures and Options

  • Hedgers : The word hedging means the reduction of risk. An investor who is looking forward to reduce his risk is called a Hedger. In the market, there can be an investor who has shares of a company X that he intends to sell on a future date. But, since there is a risk associated with future price, investor can lock the sell price for future date through an F&O contract. Such practice is called Hedging.
  • Speculators : Speculators are people who invest in securities purely to take the benefit of price fluctuations to draw profits. Speculators hypothesize expected price movements and take positions accordingly to derive profits. They take high-risk in the Derivative markets.
  • Arbitrageurs : Arbitrageurs are major participants. They are those who try to make a profit from the difference in the prices of an asset due to market conditions. Arbitrageurs try to capitalize on the dynamic environment, with decisions being made at a moment’s notice. Also, they play an important role in increasing market liquidity.

Things to know about F&O before trading

Below are few things, you must know as an investor before you trade in Future & Options:

  • Futures are leveraged products and they can amplify profits and loss equally
  • Margins on futures can go up sharply in volatile times leading to significant MTM (Marked to Market) obligations
  • Always trade F&O with stop losses and profit targets
  • You can create covered positions in options when you are not sure of the direction of the market

Conclusion :

Trading in Futures & Options (F&O) is nothing like rocket science, a proper understanding will surely help you make better use of these innovative financial products.

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