When it comes to investing in the stock market, there are multiple segments that you can participate in. There’s the spot market or the cash market, where you buy and sell shares of companies. And then there’s the derivatives market, where you get to trade in derivative contracts like futures and options of stocks and indices.
Futures and options contracts offer a great way to generate returns by leveraging the price movement of an asset. Why? Because you don’t actually take delivery of the asset until the day of the contract expiry. You can simply purchase or sell a contract, wait for a few days, and square off your position once the price of the asset moves according to your expectations. The difference between the purchase price and the selling price would be your returns.
On the other hand, in the spot market, you will have to mandatorily take delivery of the shares unless you choose intraday trading. Even then, you will have to square off your position by the end of the trading session or be forced to take delivery of the shares.
If you’re someone who is interested in trading in the derivatives segment, here’s everything you need to know about futures and options.
Investing in futures and options: Things you need to know
Before you go ahead and begin investing in futures and options, there are a few key things that you should know about. Here’s a quick look at a few of them.
1. Futures and options contracts have limited validity
Every derivative contract has a fixed validity and typically expires on the last Thursday of a month. For instance, let’s take up futures and options of stocks. You can generally find contracts with three different expiries - near month, next month, and far month.
Near month contracts expire on the last Thursday of the current month. Next month contracts expire on the last Thursday of the next month. And finally, far month contracts expire on the last Thursday of the month after the next month.
As an investor, it is important for you to know the expiry of the derivative contract that you wish to trade in.
2. Futures and options use leverage
All derivative contracts use leverage. The concept of leverage can be summed up as being able to take up far larger positions by simply depositing a fraction of the position’s value. Leverage can help multiply your profits if the price movement is in your favor. However, it is also a double-edged sword and can lead to heavy losses if the price movement goes against your expectations. Therefore, when investing in futures and options, always be cautious when using high leverages.
3. You can trade in futures and options of multiple assets
Futures and options of stocks aren’t the only derivative contracts that you can trade in. There are several other assets whose derivative contracts are also available for trade in India. This includes currencies, commodities, and interest-rate pairs. Though the asset varies, the concept of futures and options doesn’t change.
4. Futures and options can lead to delivery of the asset
With futures and options, you won’t have to take delivery of the asset as long as you square off your position before the end of the day of contract expiry. However, if you hold the contract till the end of the expiry day, you will have to mandatorily take delivery of the asset by paying the difference amount. That said, this holds true only in the case of investing in futures and options of stocks. Derivative contracts of commodities, interest-rate pairs, and currencies are all cash-settled and there are no deliveries.
Conclusion
As you can see, futures and options are a great way to create wealth in the short-term. That said, before you begin investing in them, always make sure to bring yourself up to speed knowledge-wise. Now, whether you’re trading in derivatives or investing in upcoming IPOs, having a demat and trading account is important. If you don’t have one, simply make your way to Motilal Oswal today to open a demat account and a trading account for free.