Future and Options

Futures are binding agreements to buy or sell, while options let buyers choose to trade before a set date. Both help reduce risks by locking in prices in advance.
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Future and Options
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3 mins
08-April-2025

Futures and options are major types of stock derivatives traded in the share market. These stocks are agreements between two parties to buy or sell a stock asset at a fixed price on a future date. By setting the price in advance, these contracts help mitigate market risks associated with stock trading.

The basics of futures and options help investors manage future risks by securing investments at predetermined prices. However, since price movements are unpredictable, inaccurate market forecasts can lead to significant gains or losses. Generally, those with a strong understanding of stock market operations actively engage in such trades.

Key Takeaways

  • The new STT (Securities Transaction Tax) rates for futures and options (F&O) have been revised and started on 1st October 2024.
  • The STT on futures went up from 0.0125% to 0.02%, and on options it increased from 0.0625% to 0.1%.
  • This means higher transaction costs for traders. Additionally, both BSE and NSE have introduced a uniform fee structure.

Pro tip

Invest in equities, F&O, and upcoming IPOs effortlessly by opening a Demat account online. Enjoy a free subscription for the first year with Bajaj Broking.

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Future and Options Trading

Here are some practical examples to help understand the concepts of options and futures more clearly:

  • Example of futures
    Imagine a trader enters into a futures contract to buy 100 shares of ABC Industries at Rs. 2,500 per share, with the contract expiring at the end of the month. If the market price at expiry is Rs. 2,600 per share, the trader earns a profit of Rs. 100 per share (Rs. 2,600 - Rs. 2,500), totalling Rs. 10,000. Conversely, if the price falls to Rs. 2,400, the trader incurs a loss of Rs. 100 per share, totalling Rs. 10,000. Both the buyer and the seller are obligated to settle the contract.
  • Example of options
    Suppose an investor buys a call option to purchase 50 shares of XYZ Limited at Rs. 3,000 per share, paying a premium of Rs. 50 per share. If the share price rises to Rs. 3,100, the investor can exercise the option, earning a profit of Rs. 50 per share (Rs. 3,100 - Rs. 3,000) after accounting for the premium paid. The total profit would be Rs. 2,500 (50 shares x Rs. 50). If the price drops to Rs. 2,900, the investor can choose not to exercise the option, limiting the loss to the Rs. 2,500 premium paid.

Difference between futures and options

Future and option are two derivative instruments where the traders buy or sell an underlying asset at a pre-determined price. The trader makes a profit if the price rises. In case, he has a buy position and if he has a sell position, a 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 a margin to take the buy/ sell position. To buy an option contract, the buyer has to pay a premium.

Who should invest in F&O trading?

Futures and options (F&O) trading offers significant profit potential but also carries considerable risks. It is not suitable for every investor, as it requires market knowledge, risk tolerance, and strategic planning. F&O trading is typically used by different types of market participants, each with specific objectives.

Hedgers – Managing risk in market fluctuations

Hedgers are investors or businesses that use futures and options to protect themselves against unfavorable price movements in an asset. They invest in derivative contracts to minimize the risk associated with volatility. For example, a farmer may use futures contracts to lock in crop prices, or a company reliant on oil may hedge against rising crude prices. By doing so, hedgers aim to stabilize their financial exposure and reduce uncertainty.

Arbitrageurs – Profiting from price differences

Arbitrageurs capitalize on price discrepancies of the same asset in different markets or exchanges. They buy in one market at a lower price and simultaneously sell in another where the price is higher, making a profit from the difference. This strategy requires quick decision-making and an understanding of market inefficiencies. Arbitrage trading in futures and options helps enhance market liquidity and efficiency by narrowing price gaps across different trading platforms.

Speculators – Taking advantage of market movements

Speculators invest in F&O contracts with the sole objective of profiting from price movements. They do not own the underlying asset but take positions based on expected price changes. If their market prediction is correct, they can make significant returns, but incorrect speculation can lead to substantial losses. Due to the high risk involved, speculation is best suited for experienced traders who can analyse trends and manage risk effectively.

Retail and institutional investors – Leveraging market opportunities

Both retail and institutional investors participate in futures and options trading for various reasons. Institutional investors, such as hedge funds and mutual funds, use derivatives to manage portfolio risks and optimize returns. Retail investors, on the other hand, often trade F&O for short-term gains or hedging purposes. However, due to leverage and potential volatility, retail traders should approach F&O with caution and proper risk management strategies.

Futures and options trading can be rewarding but is complex and requires a strong understanding of the market. Investors should assess their financial goals, risk appetite, and trading expertise before entering the derivatives market.

Risk Management in F&O Trading

Effective risk management is essential in future and options trading to minimise potential losses. Key strategies include:

  • Position sizing: Limiting the percentage of capital risked in each trade.
  • Stop-loss orders: Setting automatic exits to cap losses.
  • Diversification: Reducing risk by spreading investments across various assets.
  • Hedging: Using derivatives to offset potential losses in other investments.
  • Leverage control: Cautiously employing leverage to avoid amplifying risks.

These measures ensure long-term financial stability by protecting against volatility.

Conclusion

However, as previously stated, since precise price movement projections must be made, futures and options carry a significant level of risk. To make money from trading derivatives, it is important to have a solid understanding of stock markets, underlying assets, issuing companies, etc.

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Frequently asked questions

What are futures and options (F&O)?

A futures contract is an agreement to buy or sell assets at a set price on a future date. An option, on the other hand, provides the buyer with the right, but not the obligation, to buy or sell an asset at a fixed price before or on a specified date. Both futures and options (F&O) are derivative instruments commonly traded in the stock market.

Is F&O trading profitable?

Yes, F&O trading can be profitable with proper knowledge, strategic planning, and disciplined execution. Since it is margin-based, traders can take larger positions with a fraction of the total amount, increasing potential gains but also amplifying risks.

Which is better futures or options?

The choice between futures and options depends on your risk appetite and trading strategy. Futures have higher risk and potential returns, as they require contract execution. Options provide more flexibility, allowing buyers to opt out if the trade isn’t profitable, limiting risk.

How long can you hold futures?

You can hold future contracts till the expiry date.

Which is a safer future or options?

Options are generally considered safer than futures since they allow traders to limit losses to the premium paid. Futures, however, require contract fulfillment, exposing traders to unlimited losses if the market moves unfavorably. Proper risk management is essential in both cases.

How do I buy futures and options?

To invest in futures and options, you would need an F&O Demat and 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.

Is future option trading good?

The answer to whether future option trading is good or not depends on an individual's investment goals, risk tolerance, and their ability to make informed trading decisions. Futures and options are complex financial instruments that come with a significant level of risk, and it's essential to do thorough research and seek professional advice before trading in them.

What is the difference between future and options trading?

The main difference between futures and options trading is that futures are a contract that obligates the buyer to purchase or sell an asset at a specified future date and price, while options give the buyer the right, but not the obligation, to purchase or sell an asset at a specified price and date.

How risky is F&O trading?

F&O trading carries significant risks due to leverage and market volatility. Unexpected price movements can lead to substantial losses. Traders should have a solid understanding of derivatives, employ effective risk management strategies, and only trade with capital they can afford to lose.

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