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Information on Trading in Futures and Options

02 Mar 2023

One thing that all investors believe is a certainty in financial and commodity markets is the fact of price fluctuations. Fluctuations happen constantly, and prices go high and then low in reaction to different factors like an economy’s state, agricultural yield, the weather, coups, election results, government policies and wars. The list of things that are reasons for changes in price is almost limitless. 

It is obvious that individuals who deal with markets like this look for some stability in all the flux. Fluctuations in price can mean gains, but they also signal huge losses. In order to have a safety net against losses, investors can resort to trading futures and options. These are derivatives contracts that may mean less risk for investors. 

What Derivatives Are

In the simplest of words, a derivative means a contract. The contract derives its value due an underlying asset. Therefore, a derivatives contract could have any one of several underlying assets. These include commodities, stocks, currency, etc. Futures and options are just kinds of derivative contracts that traders get into for investment purposes. Unlike trading in direct stocks, you do not necessarily have to open a demat account to trade with these contracts. It all depends on the underlying assets which are traded. If you want information on trading futures and options, it's worth going into the basics first. 

The Meaning of Futures

While trading futures and options, you should be aware that one of the types of derivative contracts you can opt for is called futures contracts. You should also know that this being a contract, it's like an agreement. It's important to understand the fundamentals of any 

investment channel, and just as you would do your background checking for any upcoming IPO or stock you wish to invest in, you would want to know more about futures contracts. In a futures contract, a purchaser or a seller agrees to purchase or sell a specific quantity of a certain asset (the underlying asset like a stock), at a particular price on a preset date. There are many specifics in a futures contract. 

In futures contracts, buyers and sellers have rights - the right to buy or sell, but they have an obligation to fulfil the contract by the date specified in the contract. This means that whether the prices are high or low, you have to buy or sell. 

The Meaning of Options in Futures and Options

The other kind of contract in the segment of derivatives trading is the options contract. This also allows a buyer or a seller to buy or sell any underlying asset prescribed by the contract at a set price on a predetermined date. In contrast with a futures contract, an options contract gives a right to a buyer or seller to buy or sell an underlying asset, but there is no obligation to carry out the transaction by the set date (called the expiry date of the contract). 

Something to note in trading futures and options are the two ways that options contracts work. Hence, you could say that there exist two kinds of options contracts. These are the call option and the put option. The call option relates to a contract that gives a purchaser the right to buy an asset (at a preset price on a particular date) with no obligation. With a put option, a seller can sell an asset at a prefixed price on a preset date, without any obligation to carry out the contract terms. 

Understanding the Pros and Cons

Experts believe that futures can be an invaluable method to escape the risk that comes with fluctuations in price. Taking a very broad example to illustrate this, a country that imports oil will purchase futures in oil to cover its back from price hikes that may take place in the future. In a similar way, farmers might lock prices of their yield with the use of futures. This is so they do not run a risk of a drop in prices when the harvest is ready to be sold. 

Trading futures and options can have more advantages. Investors have the ability to freely make trades on different exchanges. For instance, it is possible for traders to make trades of stock futures and options on exchanges. Commodities contracts can be traded on commodity exchanges. While you get a grip on futures and options (F & O) trading, you should note that you can sign contracts without taking any real possession of the asset that is underlying in the contract. For example, you may not want to actually buy gold, but you can make the most of price changes with the commodity if you invest in gold futures and options. Hence, you will require much less in terms of capital to gain from price fluctuations. 

Stock Market F & O Trading

In the realm of the stock market, individuals are still quite perplexed about trading in futures and options. Nonetheless, as more and more investors gain a better grasp and become familiar with these concepts, trading has increased in the past few years. Futures and options trading is good to know about as it can really benefit some investors. 

The NSE (National Stock Exchange) launched derivatives of indexes on the NIFTY 50 benchmark in 2000. In 2022, investors can explore futures and options contracts in nine vital indices and in excess of 1000 securities. Futures and options can be traded on the BSE (Bombay Stock Exchange). 

The reason why futures and options have taken off in a big way is that you don’t have to spend any capital on the underlying asset per se. You just have to pay your stockbroker an initial margin for execution of the trade. The downside of these contracts is that if prices don’t move the way that you expect them to, you may end up losing more than you thought possible. However, in options there is less of a risk. In case prices don’t go the way you want, you have no obligation to see the contract through. You only pay your broker a premium for entering the contract. If you have a real grasp of trading futures and options, you could make good money. 

Careful Choices

Going into futures and options trading involves some study beforehand. If you were to open a demat account to invest in equity, you would do some due diligence and research company stocks. The same is with any upcoming IPO investment. Hence, if you wish to learn more about futures and options, a hands-on brokerage like Motilal Oswal can take you through the learning process. 


Related Articles: Can the commodity markets provide cues for equity trading | Beginners Guide to Agri Commodity Trading | 5 Successful Commodity Trading Strategies | Role of Commodity Markets In India 

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