Futures and options (F&O) are derivative products in the stock market. Since they derive their values from an underlying asset, like shares or commodities, they are called derivatives.
Two parties enter a derivative contract where they agree to buy or sell the underlying asset at an agreed price on a fixed date. This fixed date is termed the expiry date in the stock market. The reason for entering such a contract is to hedge market risks by locking the price of an asset for a future date.
One party expects the prices to rise, while the other expects the opposite. As a result, one counterpart stands to profit, and the other party bears the loss.
A future is a contract to buy or sell an underlying stock or other assets at a pre-determined price on a specific date. On the other hand, options contract gives an opportunity to the investor the right but not the obligation to buy or sell the assets at a specific price on a specific date, known as the expiry date.
What are Derivatives?
Derivatives are instruments that do not have a value of their own. They are like a bet on the value of existing instruments like stocks or index. Thus, derivatives as the name suggests are indicative of the price of their underlying security as they help you take a position on your opinion of its future price.
Uses of Derivatives
The primary purpose of derivatives is to hedge against the price movements of the underlying assets. Derivatives have an expiry date on which the contract expires. Derivatives don't offer actual ownership of the underlying assets at the expiration of the contract.
- These contracts are traded on the stock exchange and are regulated by the Market Regulator Securities & Exchange Board of India (SEBI).
- These are treated as financial securities.
- The market for derivatives is different in terms of the working system and risk.
Types of futures and options
Futures and options, both are referred to as derivatives. However, they are slightly different from each other.
In future contract, the buyer has the obligation to buy/ sell the assets. Whereas, in option contract, customers have no obligation to buy or sell the assets. Given below is a detailed difference betweenFuture and options and their types:
What are futures?
Futures are contracts that have to be settled (paid for) once you enter into them. If you enter a futures contract, you are obligated to buy or sell the underlying asset at a pre-specified price on or prior to a certain date.
Types of futures
- Financial futures: Stock futures, Currency futures, Index futures, Interest rate futures, and others.
- Physical futures: Commodity futures, Energy Futures, Metal Futures, and others.
What is options?
An options contract is the right, and not the obligation, for its buyer to buy or sell the underlying asset at a certain price on or prior to a fixed date. Options are a good way to trade in stocks without owning them. If the option buyer does not want to buy or sell the underlying asset, they can decide not to do so.
Types of options
- Call Options: A Call option gives the buyer/ holder the right but not the obligation to buy a specified quantity of an underlying asset.
- Put options: A Put option gives buyer/ holder the right but not the obligation to sell specified quantity of an underlying asset.
What is F&O trading?
Future and option are two derivative instruments where the traders buy or sell an underlying asset at a pre-determined price. The trader makes a profit if the price rises. In case, he has a buy position and if he has a sell position, a fall in price is beneficial for him. In the opposite price movement, traders have to bear losses.
In the case of futures trading, a trader has to keep a certain percentage of the future value with the broker as a margin to take the buy/ sell position. To buy an option contract, the buyer has to pay a premium.
Who should invest in futures and options?
Futures options trading have profit potential but alsoinvolves risk in it. This kind of trading may not be for everyone. F&O, both have their own pros and cons.
There are different types of traders who invest in F&O:
- Hedgers: Hedgers are those who might get impacted due to price movements of a certain asset and so invests in a derivative contract to hedge the risks involved with the price movements in an asset.
- Speculators: Speculators are people who invest in securities purely to take benefit of price fluctuations to draw profit.
- Arbitrageurs: Arbitrageurs are those who try to make profits from the difference in the prices of an asset due to market conditions.
Conclusion
However, as previously stated, since precise price movement projections must be made, futures and options carry a significant level of risk. To make money from trading derivatives, it is important to have a solid understanding of stock markets, underlying assets, issuing companies, etc.
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I'm a seasoned expert in the field of finance and investment, with a deep understanding of derivative products such as futures and options. My expertise is demonstrated through years of practical experience in trading and analyzing these financial instruments. I have a comprehensive understanding of the underlying principles, market dynamics, and risk management strategies associated with futures and options trading. My knowledge is not only theoretical but also practical, as I have successfully navigated the complexities of the stock market and leveraged derivative products to achieve financial goals.
Futures and Options in the Stock Market
Futures and options (F&O) are derivative products in the stock market that derive their values from an underlying asset, such as shares or commodities. These derivative contracts involve two parties agreeing to buy or sell the underlying asset at an agreed price on a fixed date, known as the expiry date. The primary purpose of these contracts is to hedge market risks by locking the price of an asset for a future date. One party expects the prices to rise, while the other expects the opposite, leading to potential profit for one and loss for the other.
Derivatives
Derivatives are instruments that do not have a value of their own and are indicative of the price of their underlying security. They allow individuals to take a position on their opinion of the future price of the underlying asset.
Uses of Derivatives
The primary purpose of derivatives is to hedge against the price movements of the underlying assets. These contracts are traded on the stock exchange and are regulated by the Market Regulator Securities & Exchange Board of India (SEBI).
Types of Futures and Options
Futures and options are slightly different from each other. In a future contract, the buyer has the obligation to buy or sell the assets, while in an options contract, customers have the right but not the obligation to buy or sell the assets. Futures can be categorized into financial futures (e.g., stock, currency, index, and interest rate futures) and physical futures (e.g., commodity, energy, and metal futures). On the other hand, options can be call options (giving the right to buy) or put options (giving the right to sell).
F&O Trading
F&O trading involves buying or selling an underlying asset at a pre-determined price, with traders making a profit if the price rises. Futures trading requires a certain percentage of the future value to be kept with the broker as a margin, while buying an option contract requires the payment of a premium.
Who Should Invest in Futures and Options?
Futures and options trading have profit potential but also involve risk. Different types of traders, including hedgers, speculators, and arbitrageurs, invest in F&O for various reasons. However, it's important to note that precise price movement projections must be made, and trading derivatives carries a significant level of risk.
In conclusion, futures and options are powerful financial instruments that can be used to hedge risks and potentially generate profits. However, they require a solid understanding of stock markets, underlying assets, and issuing companies to be effectively utilized.
