⁠ What are Futures and Options?

Futures and options are types of stock derivatives or contracts signed between two parties for trading an asset like a stock, commodity or currency traded at a predetermined price.

What are Futures?

Futures are contracts signed between a buyer and seller at a price predetermined for a specific future date. It obligates both parties to fulfil the contract on the set date, irrespective of the market price.

In case of Futures:

If you agree to buy 100 shares of a company at Rs. 600 in three months, you would have to pay Rs. 6000. If the share price goes up by Rs 650 or Rs 700, you would benefit from the extra income. However, if the share loses its value and is at the expiry date trades at Rs. 500, you will lose the value set.

What are Options?

These are contracts that give the buyer the right to choose to buy and sell at a fixed date. The buyer is not obligated in case of options. For example:

You choose to buy 100 shares at Rs 500 in two months. The prices increase to Rs 600, and you choose to buy the share and make a profit. But if the prices drop to Rs 400, you can decide not to buy the option and limit the loss.

Difference Between Futures and Options

While both F&O are intended to offer profit in the future, each offers different terms.  

• Futures are obligatory on the buyers, making it a liability for the buyer. Even if the assets trade at a loss, the buyer still has to invest and buy them on the fixed date.

For options, however, the buyer has the flexibility to decide if they want to buy the asset at a loss or not. Thus, not making them obligatory.

• Futures are risky, while options are not very risky.
• You can suffer a loss with Futures, while options offer a limited loss for the buyer.

Who Should You Invest in Futures and Options?

While futures and options trading can seem exciting, it is also risky. Futures & Options trading for beginners can be slightly complex and requires adequate market knowledge, investment planning, and risk appetite. Thus, it is crucial to understand who can invest in F&O trading and benefit from it.

Hedgers

These are investors or businesses that use F&O as a shield during volatility. They protect themselves against unfavorable price movements of an asset in the market. Locking the price of transactions at a fixed future date helps individuals seek profits if the prices rise. But extensive market fluctuations can cause losses. This is where options contracts can help mitigate the risk.

Arbitrageurs

These are investors who capitalise on the price difference of an asset in different markets and make profits. They buy assets at lower prices in one market and sell them at a higher price in another, seeking profit. It requires a thorough understanding of market indices and volatilities for appropriate decision-making.

Speculators

These investors leverage F&O trading to profit from price movements. They buy stocks based on the expected price changes. If their prediction is correct, it can help them make a profit, but if the prediction goes wrong, it will lead to losses. Thus, speculation is best suitable for experienced investors who can analyze trends and manage the risks.

Retail and Institutional Investors

Retail and Institutional investors use futures and Options trading to manage their portfolios, make short-term gains, and benefit from strategy. Institutional investors use these derivatives to optimize returns, and retail investors use F&O for hedging purposes. It is important for both parties to, however, understand the market conditions and approach F&O trading with caution and a detailed risk management strategy.  

Advantages of Trading Futures

Futures offer several benefits for both individual and institutional investors. These include:

• Futures trading allows traders to leverage, that is, to maintain a large position with a small margin deposit to increase returns from small price movements. This also increases the risk of large losses.
• It helps traders to diversify their portfolio with different asset classes.
• It helps Future traders to manage price volatility by locking sale prices, especially in airline or agricultural companies, that use them to stabilize and protect profit margins from market instability.             
• Future contracts are highly liquid, making it easy to enter or exit positions without a significant price impact.

Advantages of Options Trading

• The advantage of options trading is leverage. It requires traders to pay only the premium and not the full transactional value.
• If the market works in your favour, options help you earn unlimited profits and limit the loss.
• Options are relatively less risky as the maximum loss is limited to the premium paid.
• There is no obligation to exercise an option contract, as you can choose to let the derivative expire.

⁠Risks of Futures and Options

While Futures & Options trading offer multiple benefits, they are also inherently risky. To navigate the trading journey effectively, it is essential to understand the risks involved.

Risk of Trading Futures

• Leverages in future trading can amplify gains, but also increase losses. Even small price changes can lead to big losses, making it highly risky.
• The obligation to fulfil the contract on a fixed date makes it riskier, as market conditions might affect the gains.
• If your trade is in loss, you may be required to maintain a margin account and deposit more funds to keep the positions open.
• As market conditions, volatility, and any sudden news can impact future trades, traders must have a thorough knowledge of the market and an understanding of the contracts.

Risk of Trading Options

• Options have an expiry date and can lose value over time. Known as time decay or theta decay, the phenomenon can reduce the value of options, causing losses.
• Options are more complex than stocks and futures and require a thorough understanding. Lack of knowledge can lead to poor decisions.
•  Due to the expiration timeline, options trading can be stressful during the limited period. Impulsive decisions can lead to loss, thus making it essential to understand price movements.
• Options trading also involves leverage, which helps traders amplify profits but also causes higher losses if the market is against them.

⁠How to Get Started with Futures and Options Trading

If you are just getting started with futures and options, following these steps can make the process simple and efficient:

• You must find a reputable broker and open a trading account to start futures and options trading.
• Study the market trends, news, and price movements to understand how they influence F&O prices.
• Develop a strategy that aligns with your investment goals and make strategies that offer maximum benefits.  
• Once you have the strategy and knowledge, you can also start practising with paper trading, which involves no real money. It will help you to understand the market, its movements, how you can gain and be susceptible to losses.
• Understand that F&O trading is not immune to losses. Therefore, maintain and implement risk management techniques like stop-loss orders to minimise losses.
• Make sure to keep learning and staying informed about the trends, news and other information that can influence fno prices. Keep refining your strategies and risk assessment to gain profits.

How to Choose the Best Platform for Futures and Options

To start futures and options trading, you must select the best platform or broker that helps you achieve your investment goals. To choose the best platform, consider the following:

• Select a brokerage firm that involves low and transparent brokerage, like Zerodha, Groww and Upstox.
• Choose a platform that offers web and mobile applications with a smart and user-friendly interface, especially if you are a beginner.
• A good platform will provide you with real-time market updates, analysis and tools that help you to manage your trading effectively.
• To better understand F&O trading, make sure to select a platform that provides tutorials, webinars, and expert guidance for improved results.
• Full-service brokers, like HDFC Securities and ICICI Direct, offer daily reports and technical support to enhance your trading journey.
• The best platforms offer customer support to help you trade easily and efficiently.

⁠Advanced Strategies in Futures and Options

Once you are familiar with the basics, understanding the advanced strategies will help you enhance profits and mitigate risks. These include:

Spreads

These include buying and selling futures and option contracts with different prices or dates to limit the risks and improve profit from price movements.

Strangles and Straddles

This strategy helps to make a profit from substantial price movements in either direction, but each differs in implementation. A strangle includes buying a call and put option with different strike prices but the same expiration date. A straddle, on the other hand, includes buying a call and put option with the same price and expiration date.

Hedging

It is a risk management strategy that helps to create a safety net against uncertain price movements. Hedging includes a strategy that can offset losses by taking the opposite direction of the portfolio.

Conclusion

Thus, Futures & Options trading is an effective way to diversify the portfolio, leverage a position and hedge risks. While it has the potential to offer high profits, the risk of loss is also higher. Thus, whether you’re a beginner or an experienced trader, take the time to learn about F&O, learn market trends and develop a strong strategy for profitable trading.

FAQs – Futures and Options