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FUTURES AND OPTIONS - MEANING
DIFFERENCE BETWEEN FUTURES AND OPTIONS
TYPES OF FUTURES AND OPTIONS
Futures and Options (F&O) are “derivative products” in the stock market. Since they derive their values from an underlying asset, like shares or commodities, they are called derivatives. Two parties enter a derivative contract where they agree to buy or sell the underlying asset at an agreed price on a fixed date. This fixed date is termed the Expiry Date in the stock market. The reason for entering such a contract is to hedge market risks by locking the price of an asset for a future date. One party expects the prices to rise, while the other expects the opposite. As a result, one counterpart stands to profit, and the other party bears the loss.
A Future is a contract to buy or sell an underlying stock or other asset at a pre-determined price on a specific date. On the other hand, Options contract gives an opportunity to the investor the right but not the obligation to buy or sell the assets at a specific price on a specific date, known as the expiry date.
Normally we are aware of stocks which are traded directly in the market and are affected by market and economic conditions. However, derivatives are instruments which do not have a value of their own. They are like a bet on the value of existing instruments like stocks or index. Thus, derivatives as the name suggests are indicative of the price of their underlying security as they help you take a position on your opinion of its future price.
The primary purpose of derivatives is to hedge against the price movements of the underlying assets.. Derivatives have an expiry date on which the contract expires. Derivatives don't offer actual ownership of the underlying assets at the expiration of the contract.
These contracts are traded on stock exchange and is regulated by the Market Regulator Securities & Exchange Board of India (SEBI).
These are treated as financial securities.
The markets for derivatives is different in terms of the working system and risk.
Although, Futures and Options, both are referred to as derivatives, they are slightly different from each other.
In Future contract, the buyer has the obligation to buy/sell the assets whereas in Option contract, customer have no obligation to buy or sell the assets.
Here are some basic terms that will be helpful to understand F&O.
Underlying Security: An underlying security is the primary element of the futures and options through which this derivative contract derives its value.
It can be a stock, bond, currency, interest rate, index, or commodity on which F&O are based.
Strike Price: Strike price is a price at which the options contract owner agrees to buy or sell the underlying asset at the time of exercising the contract.
Premium: Premium is the current price (or a fee) of an options agreement paid by the option buyer to the seller. It is quoted on the Exchange as a rule. The higher the volatility of the underlying asset, the higher the premium.
Expiry Date: It is the fixed date by which the options must be exercised otherwise it will be expired.
Additional Read: What is Demat Account
An options contract is the right, and not the obligation, for its buyer to buy or sell the underlying asset at a certain price on or prior to a fixed date. Options are a good way to trade in stocks without owning them.
If the option buyer does not want to buy or sell the underlying asset, they can decide not to do so.
There are two types of options: Call Option & Put Option.
Call Options: A Call Option gives buyer/holder the right but not the obligation to buy specified quantity of an underlying asset.
Put Options: A Put Option gives buyer/holder the right but not the obligation to sell specified quantity of an underlying asset.
Futures are contracts which have to be settled (paid for) once you enter into it. If you enter a futures contract, you are obligated to buy or sell the underlying asset at a pre-specified price on or prior to a certain date.
Financial Futures: Stock futures, Currency futures, Index futures, Interest rate futures and others
Physical Futures: Commodity futures, Energy Futures, Metal Futures and others
Future and Option are two derivative instruments where the traders buy or sell an underlying asset at a pre-determined price. The trader makes profit if the price rises in case, he has a buy position and if he has a sell position, fall in price is beneficial for him. In the opposite price movement, traders have to bear losses. In the case of futures trading, a trader has to keep a certain percentage of the future value with the broker as margin to take the buy/sell position. To buy an Option Contract, buyer has to pay a premium.
Future and Option trading though have profit potential but also involves risk in it. This kind of trading may not be for everyone. F&O, both have their own pros and cons.
There are different types of traders who invest in F&O:
Hedgers: Hedgers are those who might get impacted due to price movement of a certain asset and so invests in a derivative contract to hedge of the risks involved with the price movements in an asset.
Speculators: Speculators people who invests in securities purely to take benefit of price fluctuations to draw profit.
Arbitrageurs: Arbitrageurs are those who try to make profit from the difference in the prices of an asset due to market conditions.
1. What is futures and options with examples?
Futures and Options are derivative contracts that can be bought and sold in the share market.
Futures contract is where the buyer and seller of the contract agree to transact in the underlying asset on a future date at a price determined in advance.
Example: Consider a futures contract of company ABC with an expiry date of 25 Aug is available at Rs.100 (current price of ABC shares in live market is 105.) The buyer of this futures contract is making deal with the seller that on 25 Aug, he will buy ABC shares at Rs.100 per share irrespective of what the market price is on 25 Aug.
In Options contract, the buyer and seller of contract agree to transact in the underlying asset on a future date at a predetermined price. However, here the option buyer has the right but not the obligation to execute the contract on the expiry date.
2. Is F&O trading profitable?
If you get your basics right, it is possible to be profitable in F&O trading. One reason retail investors get enthused about Future and Options trading is that it is a margin base trading, that is, a higher value position can be taken by just paying a portion of the full amount.
3. Which are better options or futures?
Both Option & Future have unique properties and serve as hedging tools for traders and investors. Each has its distinct functionality that can be useful in one or the other instance for a trader.
4. How long can you hold futures?
You can hold future contracts till the expiry date.
5. Which is a safer future or options?
Both Future and Options carry risk. Also, since these are leveraged instruments the extent of profit and loss, both are magnified.
6. How much money do you need to trade futures?
In the stock market, you can trade in the Future of indexes and stocks. Each Future contract has a different contract price. The margin requirement is specified by the Exchange and depends on the volatility of the underlying asset.
7. How do I buy futures and options?
To invest in Future and Option you would need a Demat and Trading Account.
All you need is an-F&O activated Demat & Trading account.
To invest in Futures, the investor pays a margin which is a portion of the total stake to take a position. Once the margin is paid the Exchange matches your order with available buyers or sellers in the market.
On the other hand, in Options, the buyer of the contract selects the desired strike price and pays the respective premium to the seller of the contract. Whereas the seller of Options deposits a margin to take the position.
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