What is Futures & Options (F&O) Trading?
Futures & Options trading are two types of financial derivatives trading in which investors can participate in the financial markets without directly owning the underlying assets.
FUTURES TRADING
Futures are standardized contracts that obligate the buyer to purchase, and the seller to sell, a specific quantity of an underlying asset (like a commodity, stock, or financial instrument) at a predetermined price on a specified future date. It's used for hedging against price fluctuations and for speculative purposes. For example, a farmer might use futures to lock in a price for their crop before it's harvested to protect against a potential price drop.
OPTIONS TRADING
Options are contracts that give the holder the right (but not the obligation) to buy (call option) or sell (put option) a specific quantity of an underlying asset at a predetermined price before or at the expiration date. Options provide flexibility for investors. Call options can be used for hedging or to make profit on price increases, while put options can be used for hedging or to profit from price declines.
KEY DIFFERENCE BETWEEN FUTURES & OPTIONS
| FUTURES | OPTIONS | |
|---|---|---|
| Obligation | In futures trading, both parties are obligated to execute the contract on the specified future date. | In options trading, the buyer has the right, but not the obligation, to execute the contract. |
| Risk and Reward | Futures trading can lead to unlimited gains or losses, depending on the price movement of the underlying asset. | For an option buyer, options trading limits the potential loss to the premium paid for the option, but offers unlimited profit potential. |
| Liquidity | Futures markets tend to be more liquid and standardized compared to options markets. | Options markets is less liquid compared to Futures markets. |
Futures Contract Example:
Imagine you're an investor looking at the stock of Company XYZ. It's currently priced at Rs.1,200 per share. You anticipate the price will go up in the next three months.
You decide to enter a Futures Contract for 100 shares of XYZ, set to expire on February 1, agreeing to buy them at Rs.1,250 per share.
If, by February 1, XYZ's shares have risen to Rs.1,300, you still buy at Rs.1,250, making a profit of Rs. 50 per share. If the price drops to Rs. 1,100, you'll still buy at Rs. 1,250, incurring a loss of Rs.150 per share.
Options Contract Example:
Now, consider an Options Contract for Company DEF's stock. It's currently at Rs. 800 per share, and you believe it could rise or fall dramatically in the next two months.
You purchase a call option for 100 shares of DEF. This contract has a 'Strike Price' of Rs. 850 and expires on April 1. You pay a 'Premium' of Rs. 20 per share.
On April 1, if DEF's stock has risen above Rs. 870 (Rs. 850 strike price + Rs. 20 premium), you can choose to buy the shares at Rs. 850, potentially selling them at a profit. If the price remains below Rs. 850, you might decide not to exercise the option, limiting your loss to the premium paid.
Both F&O trading involve a level of risk and require a good understanding of the market.They are utilized by a wide range of participants including speculators, hedgers, and arbitrageurs to achieve various financial objectives.It’s important for individuals to carefully consider their risk tolerance and educate themselves before engaging in these types of trading activities.
Some of the Indices traded in the Indian Stock Market are: * NIFTY * BANKNIFTY * MIDCPNIFTY * FINNIFTY * SENSEX * BANKEX * NIFTYNXT50
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