Better for Returns: Equity or Futures and Options | Motilal Oswal

What is Better for Returns : Equity or Futures and Options

Investors and traders are actively engaged in investment activities for a primary reason. They may enjoy trading, and some individuals are “addicted” to the activity, but the simple truth is that most are in it for the money. Obviously (and naturally), investors want returns on investment, and some may want to see gains faster than others. The share market, today provides investors with ample opportunities to make good returns. However, to a large extent, returns do not depend on what you invest in but rather on how that investment is made.

Investors, at least the serious ones, may indulge in a lot of introspection before investing, by gauging risks and rewards adequately. If you are an investor, going deep into the share market live, you may find that investing in direct equity is the popular way of investing. This involves the buying and selling of stocks of a company. You should also know that you can invest in equity through contracts like futures and options. Rather than an actual asset, futures and options are channels through which you invest in assets via contracts to purchase and sell underlying assets. However, if your focus is on returns, you’d probably like to understand which route gives you more - direct equity or futures and options trading. The answer lies not just in the method of investment, but in your goals and your purpose of investment. 

What is Right for You?

Not everyone understands this, but investing is a very personalised activity. What investment is suitable for you may not be appropriate for the next investor. For instance, stocks appeal to beginners and those investors with a long-term view of the share market today. So if you open a demat account and start investing in stocks (direct equity), your investment horizon is likely to be for the long haul. You may well use a buy-and-hold strategy as you wish to see good returns at some point in the future. 

On the other hand, futures and options represent a way to invest in equity and are not direct assets in themselves. These are contracts that investors sign up for, to sell or buy particular stocks at predetermined times. This can benefit investors who wish to receive returns in the shorter term. However, once you get into contracts, you may well run the risk of having to execute them, whether your stock price is up or down. So, if you're open to some risk, you may go ahead and invest in futures and options. Needless to say, several investors in the stock market today go in for futures and options, but you should be a somewhat seasoned investor to gain substantial returns. If you first understand the differences between concepts, that is, equity, futures and options, you may get a clue as to which can offer better returns for you specifically. 

Equity

There are many ways in which you can invest in equity. Equity, or stocks, are financial instruments reflecting your part ownership in a company, if you choose to buy them. You can invest in any upcoming IPO and be assigned a bulk of shares of the company you subscribe to or invest in stocks of a company directly buying from an exchange. Nonetheless, when you purchase stocks of any company, you become a stockholder (or a shareholder), and you are entitled to proportionate shares of any company assets  (according to your percentage of ownership). Stocks are mainly traded via stock exchanges, and you can log on to the share market live online and conduct trades (buy and sell stocks). 

If you view stocks or shares (equity) from a historical standpoint, they have outperformed other classes of assets over long periods. The idea of investing with serious investors is to buy blue chip stocks (companies that hold a high status in different segments of the industry) and hold them for the long term. The ability of good quality stocks to withstand market volatility and other factors like inflation has long since been recognised and proven to give great returns in the future. However, many investors get impatient, wanting to have returns almost overnight. Direct equity may not suit such investors. 

Futures 

You may be an experienced hand in the share market today, with a historical record of good investments. You can venture into the world of futures. These are basically contracts which are official agreements to purchase or sell specific commodities, securities, or assets at a certain fixed price at a predetermined date in the future. In order for trading to take place without any complications, contracts of futures have to be standardised with regard to quantity and quality. When investors purchase a futures contract, they automatically assume the obligation to buy and take receipt of the underlying assets at the contract's expiry date. Now, whether the price of the underlying asset falls or goes up, the obligation to uphold the contract rests with the investor. Hence, there is obviously some risk involved here. 

Equity or Futures?

Futures are contracts of a derivative nature - they derive their value from any financial asset, like a conventional stock, stock index, or bond, and hence, can be effectively used for you to have exposure to a range of financial instruments. These may run the gamut from stocks and indexes, to commodities and currencies. If you wish to see returns from futures, you can easily turn to the share market live and invest. They make an excellent vehicle for you to hedge and manage risk; in case investors are already facing prospects of profits through speculation, this is mainly because of the desire to hedge risks. 

Due to the way in which futures contracts have their structure and are traded, these may have inherent benefits over direct equity. Although they seem complicated at first, they can, in a calculated way, give some good returns. The single biggest advantage of futures is that they are extensively leveraged financial instruments. To trade in futures, investors must place margins (normally 10% of the value of the futures contract) with their brokers. These margins act as collateral in the event that markets move in opposition to positions taken by investors and hence lead to losses. In case prices rise, profits may be had, but if they fall, and further than the margin amount, investors must make up for this loss. Therefore, in the stock market today, if you are thinking of returns to be had, it all depends on the movement of markets, whichever way you go in terms of the method of investment. 

High Liquidity

Direct equity investment can give you good returns provided you hold stocks of good quality and your holding is one of patience. This has been proven time and again with respect to stocks across all segments and industries and across any exchanges. In this way, if you tide over periods of market volatility and stick with your equity investment over the long run, you can see liquidity in terms of the substantial returns you can earn. 

Now, if you turn your attention to futures contracts, these are considered to be inherently liquid as they are traded on a massive scale, in large numbers. In futures markets, there is a constant presence of both buyers and sellers. This ensures that market orders are placed quickly in the share market today. In some contracts, this may entail that prices do not change drastically. Moreover, since futures markets (some) trade 24 hours a day, you can make the most of opportunities to earn returns. 

Options

The word “options” gives you some idea about how an options contract works. Again, investors can enter options contracts, agreeing to purchase or sell underlying assets at a certain date, at a specific price. Underlying assets are typically stocks, but they can be commodities too. Depending on the kind of options contracts, investors can purchase or sell assets, but there is no obligation to do so. The “option” lies with the investor. The investor may exercise it or not. This may seem like a good bet on the face of it, but you should grasp how options really work, to know if you will see good returns. 

In the stock market today, there are two kinds of options contracts that investors may enter: call options and put options. In a call option, an owner of an options contract agrees to purchase an underlying asset at a specific price at a particular date (or until that date). Hence, if the underlying asset is a stock, for example, the call option will rise in value when the price of the stock increases. Technically, when investors purchase call options, they expect that stock prices will go up. With regard to a put option, an investor agrees to sell any underlying asset, such as a stock, at a certain price until or on a specific date. If the price of a stock decreases, the put option will rise in its value. Therefore, your speculation for a put option will be that prices will fall. 

Equity and Options

Being aware of the different aspects of the methods of investment will let you decide what instruments and assets hold more returns for you at an individual investing level. The share market today is rife with opportunities galore, and though you may have heard about investors “making big bucks”, the reality may not be the same for you. 

The first thing to note is that investing in equity, however it is done, poses some level of risk. The potential upside of investing in stocks is high, and that of options is very high (and very fast). If you consider the aspect of holding (time horizon) of stocks vs equity, you can hold equity for a lifetime. This increases your chances of good gains. Hence, if you have bought equity while you are young, you can almost assuredly consider good returns by the time you are nearing retirement age. In the case of options, contracts can be held for limited periods only - about two years with regard to public options, but often held for a few weeks to months. Therefore, the chances of returns may be limited as the holding timeframe is restricted. 

Factors Affecting Returns

The returns on any investment are of prime importance to investors whether seeking long-term or short-term gains. As a result of this, investors will try to discover the best way to earn returns based on their financial goals. Moreover, they will attempt to curb any variables that may interfere with returns and avoid making returns redundant. 

Whether you are trading in the share market live online, or through a broker, you may or may not have to incur certain costs like brokerage commissions. Major brokerages online typically don’t charge these, but you will have to check for brokerage fees. In terms of futures and options, there may be fees involved (such as a premium in options contracts) that are charged per contract. This may eat into your returns, depending on the size of your contract and the fees levied. Furthermore, you must make it a point to know about the taxation involved while dealing in equity and futures and options. This depends on your holding period, and you may be eligible for short-term capital gains tax or long-term capital gains tax. 

Lessons About Stocks

Several traditional investors, and some seriously experienced ones, will tell you that you should start your foray into an investment with direct equity investing. Before you attempt to veer towards futures and options, equity will give you a better understanding of how transactions in the share market today work. If you do your research well, you will find out the following lessons about returns that result from equity investment: 

  • Stocks are able to deliver high potential returns without too much risk involved. If you invest in a diversified stock portfolio, like an index fund, you can balance risk and reward and win in the long run. 
  • As long as the company whose stock you have invested remains afloat, your stock can be held. Hence, in a way, stocks have a lifetime that is infinite, and thus, more time for you to yield returns on investment. 
  • One of the main advantages of holding stocks is that they give returns in the form of dividends, and not merely when their value increases. The best stocks tend to grow their dividends on a yearly basis, and this puts more capital in your purse over a period. 
  • You would not be wrong to think of the stock market today as a place to get your returns. There are more ways than one to earn returns from stocks. For instance, if the acquisition of a company takes place at more of a premium than its market value, shareholders may be rewarded. 
  • Nowadays, the purchase and sale of stocks are convenient and easy, besides being cheap. With a reduction in trading commissions, in attempts to get more investors into the stock market, you can earn more as you save on additional administrative costs. 

Futures and Options, and Returns

As much as you have advantages of stock trading, you may find some benefits in investing in F & O (futures and options). In relation to the potential for returns, here are some things to ponder: 

  • As usual, the returns you may seek from your investment depend on your unique financial goals. For investors who wish to have returns quickly, futures and options may seem like a solution. With options, especially, you can earn high returns over a brief span. The power of leverage enters the picture here, turning small amounts of capital into sums of a large value. 
  • It is common knowledge that equity investing can be volatile. However, trading in F & O can be even more volatile, but this is what attracts investors to potential gains via F & O. 
  • Generally, trading in futures and options, mainly options, can be a risky prospect. However, investors employ specific strategies that can enhance returns by reducing risk. 
  • While trading in the share market live, owning options at the right time might prove fruitful. Just like stock investment, if a company is acquired at a premium relative to its market value, you will reap the rewards as an investor in such a company. 
  • You can trade in F & O at low costs, and brokers constantly reduce fees so that returns may be kept high. 

Some Considerations 

Doing your homework in advance of your investment is always a good plan. Since you are investing in the share market today, you should be prepared for fluctuations in price and value. These volatile periods affect both investing in direct equity and futures and options. Prices may change from one year to the next and even from one month to the next. The main idea to get rewards out of any of your investments is to pick the right stocks with regard to equity, and the right underlying assets with regard to futures and options contracts. Generally, equity poses less of a risk than futures and options contracts, and if your risk appetite is not high, you may want to delve into direct equity. You can always try F & O after you have some knowledge of the equity markets. 

When trading in futures and options, your investment thesis must be correct in the appropriate time period. For instance, you will see no returns if a stock’s value increases after your contract has expired. In addition, you may want to consider the fact that prices fluctuate wildly on a daily basis when you are into F & O. Price fluctuations of 50% and above can be common, and this will tell you that you may see a decline in your returns. 

Assessing Your Investment

What is better for returns, stocks or futures and options? The answer rests with you, the individual investor. Stocks may be a good bet when you want experience in the markets. Although investing in the share market today requires work and analysis, investing in futures and options requires even more of this. Analysts may advise you to start investing with mutual funds or ETFs, but you can start in equity in a small way, choosing your handpicked companies wisely. Investing in equity should be for the long road ahead and isn’t really gainful for the short run. Investors must ride out the lows before seeing the benefits of the highs in stocks. In the case of futures and options, there is a date of expiry involved, and with such a short-term nature, your contract may expire before any returns can be experienced. 

Prudent Choices

Investing doesn’t simply mean that you open a demat account and start buying and selling shares. Investing should represent a way to place your capital in any asset and instrument so that it may grow. In the present day, you can make equity investments in a number of ways and go in for an upcoming IPO if you believe in the future success of a given company. 

Coming to futures and options, they serve as a good choice in case investors wish to limit their risk to a specific amount of investment. With options, especially, investors can achieve a share-like return while investing a restricted amount of capital. If you are an experienced investor, futures and options may give you good returns as you know how to place limits on risk and understand risks while employing certain strategies. Furthermore, some strategies permit investors to buy equity at better prices. For instance, a technique like “writing puts” lets investors collect premiums for the potential to purchase stocks at lower rates. 

The stock market today gives you ample opportunity to invest after taking informed and educated decisions. The bottom line vis a vis equity and F & O is that each of these offers you distinct returns and risks. Investors who are interested in either of these should grasp their working before taking any drastic steps. Trading and investing should never be guesswork, and the assets and instruments you choose should be based on your own characteristic future goals. Only you can know what’s best for you. 

 

Related Articles: Follow these 5 Expert Advices to Get Started with Investing | 5 Rules Every New Investor Must Know Before Investing | 6 Stock Market Investing Disasters To Stay Away From |  10 common mistakes made by SIP investors | 4 Smart Must-Follow Investment Tips for Beginners in India

 

  • Open your FREE Demat Account in 5 Minutes
+91|
Select State
Select City
By submitting your details, you are authorising us to call you or send promotional communication even though you may be registered under DND
angle-up