After understanding Derivatives and their market landscape let us move on to the instruments that turn Derivatives into lucrative instruments for traders. As we already know, in a derivative market, we can either deal with Futures and Options trading.
Options are derivatives, which mean that this financial instrument gets its worth not from its own intrinsic value but derives its value from the underlying security and time. For example: Options contracts on the stock of reliance are directly influenced by the price of Reliance stock.
A futures contract is a security conceptually similar to a stock or a bond, but with a significant difference. While a stock gives you equity and a bond makes you a debt holder, a futures contract is a legally binding document that sets the conditions for the delivery of commodities or financial instruments at a specified time in the future. Futures contracts are available for more than just mainstream commodities. Some futures contracts are even designed to hedge against weather risk. Now, virtually all financial and commodity markets are linked, with futures and cash markets functioning as a single entity on a daily basis.
Both Futures and Options contracts are securities that require binding agreements. However, in Options you have the right to buy or sell an underlying security or asset without being obligated to do so, as long as you follow the rules of the contract.
Investing in Futures and Options trading is not without risks. Many experienced traders say that you need a lot of money to begin trading in Futures and Options. But there are people who’ve made fortunes starting small. So the reality is that different people fare differently depending on their trading ability, irrespective of the experience. A trader with 10 lakh in equity can lose or gain large amounts just as easily as you could with 1lakh worth of equity in your account.
Futures and Options trading is risky business and requires you to be active at all times. You’ll see success in the trade only if you’re serious and committed. And overtime you’ll develop your trading craft by constantly reviewing and modifying your plan and strategies.
Stay connected to the market at all times to be successful in Futures and Options trading and there are so many places oozing with knowledge - Internet, television, and financial websites, reports.
Answer these questions before beginning
You need to know what you’re getting into before you start your Futures and Options Trading. This checklist has some key questions that can help direct your research as you consider trading futures and options.
Are you trading an Indian or a foreign option? And is it an exchange-traded or dealer-traded option? Exchange-traded options have standard contracts that are more liquid and can be hedged better against risk. Dealer-traded options don’t necessarily follow this.
Who is guaranteeing the transaction? Foreign institutions don’t necessarily follow stringent norms, and might not be well monitored. So if you’re trading with foreign institutions check their individual futures and options contracts thoroughly, especially if the foreign futures and options are not traded through the exchange.
Are you unnecessarily paying extra premium? Sometimes, independent dealers charge a very high fee and hide it under the name of ‘premium’. It’s very important to know that you pay the option premium plus a commission charge; the commission is not imbedded in the option premium.
What is the break-even price for your option? How much does the price of the option have to grow before you start making money?
Are you transparent with your broker and know how to be in touch? Keep conversations about your Futures and Options trading very fluid and regular. How will you and your financial advisor communicate and how often? What will you receive when you do? Please read and understand the terms of the management contract carefully before you put any money down.
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