Futures and options represent contracts that trade in stock derivatives in the share markets. In the simplest way, to trade futures and options means to agree to buy or sell securities at a specific date and at a certain predetermined price. By stipulating the price in advance, futures and options contracts tend to safeguard investors against future price changes. While several investors deal in F & O trading with stock brokers, it is always recommended that their functioning is understood before taking the plunge to sign F & O contracts.
Futures & Options - the Difference and How to Trade
The twin share derivatives of futures and options share common characteristics, but are markedly distinct in key aspects. Both futures and options derive value from an underlying asset such as commodities, shares, ETFs (exchange traded funds), market indices and more. When you trade futures and options, you trade with a future consideration in mind. Although you do not have to open a demat account to trade in futures and options, you will require a brokerage account. You are permitted to trade in derivatives at the NSE (National Stock Exchange) or the BSE (Bombay Stock Exchange). Once you know the differences between the two, you will know how trading in F & O is conducted. The differences highlighted below:
- An Obligation vs. a Right - Futures refer to a commitment to trade and this must be squared off by a particular date. Where options are concerned, the investor has the same right to trade (buy or sell assets), but no obligation to execute the contract by the date stipulated.
- The Date of the Trade - A futures contract holder must conduct the trade at the date which is agreed upon. Options give the investor more variation and options can be exercised before the contract expires. In the exercising of options in India, there are some nuances regarding rules of conduct for stocks vs. indices. For instance, a stock option may be exercised at any point before the options contract expires, but an index option must only be executed on the date of expiry of a contract. These factors may be deciding factors in F & O trading.
- Risk Factors - You may think that futures and options mitigate your risk, relative to investing in any upcoming IPO or directly investing in securities. However, this depends on whether you go in for a futures trading contract or options contract. In a futures trading contract, investors have to carry out trades on a specified date, irrespective of the prices of underlying assets. In an options contract, investors have the freedom to opt out of executing contracts. Consequently, in a theoretical way, options really reduce your risk of loss. However, something to note is that in options trading, a premium must be paid to a broker. Therefore, in options trading, almost 97% of trades tend to expire with no trade executed. In such cases, premiums to brokers still have to be settled.
- Payments in Advance - When entering a futures contract, there are no initial payments involved. You make any service payments only when you square off contracts. Nonetheless, futures contracts do require you to keep a “margin” with your broker, which is a percentage of the trade value. So, the leverage can magnify any losses or gains. In F & O trading, when you purchase an options contract, you have to pay a premium to your broker. This is applicable whether a trade is conducted or not.
Trading Made Easy
If you are a hedger or speculator, trading in futures and options may be good for you. Futures trading may seem a lot riskier than options, but consider the premiums that options trades require of investors. One advantage of trading in F & O is that you do not have to undergo any processes like you do not need to open a demat account. While you explore this route to invest, you can also delve into any upcoming IPO as a good investment prospect.
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