A futures transaction involves a trader buying a set of goods at a predetermined price, at a predetermined date. For example,buying wheat before the harvest has happened for the year. Say you buy 10quintals of wheat for Rs. 50000 to be paid after 6 months. In the interim, as per how the wheat market fluctuates, the price for wheat may go down or up. Say the favorable weather conditions for wheat remain then the price will go up,say the global demand for wheat goes down since everyone is adapting to maize then the price will go down. Basis this, the trader will make a profit or a loss when he sells this wheat.
The above was in reference to the commodities market. Another market where a futures transaction is prevalent is the very volatile, very specialized derivatives market.
Trading in Options
Among the range of diverse derivatives, an option is perhaps one of the most common forms. It 's a provisional contract that gives one right to perform a transaction with the other at a specified date on specified terms. It only gives the right but not the obligation, until its due. Options have wide applicability. A company might issue a contract in the form of a bond that it can promise to buy back ten years later at a set price. These options are traded stand-alone on exchanges, also known as OTCs. Beyond the company issuing them and the first buyers purchasing them, the bonds take a life of their own in the open secondary market. The OTCs are linked to a wide basket of underlying assets. They are typically linked to stocks these days but they could be linked to diverse asset classes like currency, commodities, swaps,bonds, etc.
There are two main types of options: Call and put options. To understand why the value of calls and puts fluctuate when the market moves upand down, you need to understand what each type of option gives you the right to do once you have purchased it.
A call option gives you the right to buy a stock from the investor who sold you the call option at a specific price on or before a specified date. For instance, if you bought a 35 October call option on Reliance Industries, the option would come with terms telling you that you could buy the stock forRs3500 (the strike price) any time before the third Friday in October (the expiration date). What this means is, if RIL rises anywhere above Rs3500 before the third Friday in October, you can buy the stock for less than its market value. Or if you don 't want to buy the stock yourself or exercise the option, you can sell your option to someone else for a profit.
The drawback is if RIL never rises above Rs3500, your option won 't be worth anything because nobody wants to buy an option that allows them to buy a stock for a higher price than they could get it for if they just went out into the open market and bought it.
A put option gives you the right to sell a stock to the investor who sold you the put option at a specific price, on or before a specified date. For instance, if you bought a 25 October put option on TCS, the option would come with terms telling you that you could sell the stock for Rs2500 (the strike price) any time before the third Friday in October (the expiration date). What this means is, if TCS falls anywhere below Rs2500 before the third Friday in October, you can sell the stock for more than its market value. And if you don 't want to sell the stock yourself, you can sell your option to someone else for a profit.
Now, you have to keep in mind that to make money you will not have purchased a put option on a stock that you own (although this can be a legitimate hedging strategy). If you owned the stock, the gains you would make on the put option would be offset by the losses you would incur on the stock.Instead, you would buy a put on a stock you don 't own and then buy that stock right before you are ready to exercise the put. For instance, if you have purchased a put on TCS with a strike price of Rs2500, and the stock dropped toRs2000, you could go out into the open market, buy the stock for Rs2000 and turnaround and sell it for Rs2500, making a Rs500 profit.
The tricky part about options is that they expire. If you don 't sell or exercise your option before the expiration date, you will lose your entire investment. That 's a scary proposition, so you need to take care to always watch your expiration dates.
Options are no longer just for large institutional investors. You too can take advantage of the flexibility and leverage these wonderful trading tools offer.
Calls increase in value when the underlying security is going up, and they decrease in value when the underlying security declines in price. Puts increase in value when the underlying security is going down and decrease in value when it is going up. So depending on what you anticipate happening in the market, you can buy a call or a put and profit from that movement.