Futures and Options Trading: Key Concepts Every Trader Should Know

NSE was the first exchange to introduce trading futures options on individual securities in 2001. Futures and options trading or investment are different from equity investment in many ways, and understanding their concepts is crucial. F&O contracts are time-bound agreements. Before starting your F&O journey, you must understand what is future and option trading. Here is a guide to things you must know before you start your trading.

What are Futures and Options?

Futures and options are financial products traded in the share market. Basically, F&O is an agreement between two parties to trade a stock or index at a decided price or level at a future date. By specifying the price of the trade, both these derivatives protect the investor from future changes in the stock market.

Also read: What Is Futures And Options? Meaning, Difference, Types and Example

Difference Between Futures and Options

Although both are stock derivatives, there are some differences in certain key respects:

1. Duty Vs. Right

Futures are a commitment for both the buyer and seller. They have to square off the trade at a specified date at a pre-established value of the underlying asset. On the other hand, options give the buyer the right but not the obligation to exercise the option on expiry. The seller has to fulfill the obligation if the buyer exercises the option.

2. Date of Trade

In the case of options, you can exercise some trades at any date until their expiry, while this is not the case in the future, where the holder needs to trade at the agreed-upon date.

3. Upfront Costs

While buying an option, you need to pay a premium, you don’t need to make advance payments when entering a futures contract. You only need to pay when you do the trade in the futures contract on a pre-mentioned date.

Also read: Difference Between Futures and Options: Everything You Must Know

Future and Option Trading for Beginners: Things to Know

Before investing, there are certain things beginners must know doing futures and options trading:

1. Options are Asymmetrical

Options trading is asymmetrical. This means that the buyer’s loss is restricted to the premium, while the seller’s loss can be unlimited.

2. Buying Options Places Limited Risk

Many F&O traders buy options as your risk is capped to the premium. The sellers of options make more money than the buyers as they take a higher risk. Future trading is better than options trading in futures and options trading. But it all depends on how you trade and how much risk you can take.

3. Leverage is Two-way

Futures are leveraged products, meaning you can magnify profits and losses. Be aware that the influence of leverage through margins works both ways, in the case of profits and the case of losses.

4. Margins Can Go Up in Volatility

In times of market volatility, margins can increase sharply in the future. Most investors think that futures have a benefit over cash market buying, as you can control them by buying on margin. However, these margins could rise significantly during volatile times, requiring you to bring in fresh margins, or your broker will cut your positions.

5. Set Stop Losses and Profit Targets

While you trade futures and options, approach it as a trader, not an investor; therefore, your target is to safeguard your capital. To do this, set stop-loss and profit-taking levels for each trade and follow them religiously.

6. Keep an eye on Trading Costs

Keep track of the costs that you incur in futures and options trading. While brokerage and other costs may appear lower than equity in percentage terms, they add up quickly in the case of F&O. In F and O trading, you must pay brokerage, statutory charges, stamp duty, and other charges.

7. Applying Non-directional Strategies

One of the most long-lasting features of the F&O trading market is the ability to implement a non-directional strategy. When unsure of the direction, combine futures and options trading. Options are a solution in volatile markets.

Also read: Step-by-Step Guide to Futures and Options Trading for Beginners

How to Trade in Options & Futures?

You can open a Demat account with SMC Global Securities to start trading in F&O.

1. Futures and Options Trading in the Stock Market

You can trade futures and options at the NSE and BSE. With NSE, you can trade futures and options in 5 major indices and more than 180 securities. Options and futures are traded in contracts. The maximum duration for a futures contract is three months. Typically, in a futures and options trade, the traders only pay the difference between the specified price and the market price.

2. Futures and Options Trading in Commodities

Futures and Options trading is very common in commodities exchanges, including National Commodity & Derivatives Exchange Limited (NCDEX) and Multi Commodity Exchange (MCX). The unpredictability of these markets is a reason for high derivative trading in commodities. As the prices of commodities could change terribly, futures and options protect traders from sudden changes in the market.

Process of Futures and Options Trading

To start trading in F&O, read on to know the process of futures and options trading:

1. Open a Trading Account

Create a trading account with a registered broker on the BSE or NSE to trade futures and options contracts.

2. Login to the Portal

Once your trading account is created, log in to the portal. Otherwise, download the mobile app to look for the available F&O options.

3. Research and Choose

Research the various futures and options to determine what aligns best with your financial goals.

4. Place your Order

After making a choice, add the order details, and you are ready to buy futures and options at the strike price, whether a call option for an estimated increase or a put option for a predicted decline.

5. Understand the results

Now, when you have purchased your options contract, three outcomes take you to the next step:

• Offset the Position: Selling the options contract before the expiry to close the position is called offsetting the position. Offsetting the position may lead to profit or loss for the seller based on the price at which the underlying asset is sold.
• Exercise the position: Exercise the call options contract when the underlying asset’s price surpasses the strike price. Similarly, exercise a put options contract when the underlying asset’s price is lower than the strike price.
• Contract Becomes Worthless: The options contract becomes worthless if the underlying price of the asset does not meet the strike criteria.

Conclusion

F & O trading may seem challenging for most people beginning their trading journey. However, learning how to trade futures and options is not rocket science. Understanding f&o trading basics with examples through other similar blogs written on our website to grasp the relevant terms and approaches.

FAQs

1. What is Futures Trading?

Futures trading involves buying or selling a contract representing a specific asset, like stocks or commodities, at a predetermined price on a set future date. Traders do not need to own the asset to trade in futures; they speculate on the price movement instead.

2. What is Options Trading?

Options trading gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price within a particular time period. There are two types of options: call options (the right to buy) and Put options (the right to sell).

3. How is Futures Trading different from Options Trading?

In futures trading, both parties must complete the transaction on the expiry date, regardless of the market conditions. In options trading, the buyer can execute the trade or let the option expire if it’s not profitable.

4. Why do people trade in Futures and Options?

People trade in futures and options to hedge against risks, diversify their investment portfolio, or speculate on price movements for potential profits. It offers flexibility and leverage but comes with high risk.

5. What does it mean by expiry date in Futures and Options?

The expiry date is the last day on which a futures contract or an option can be traded. Depending on the terms, the contract must be settled in cash or by delivering the actual asset after this date.

References:

https://www.indiainfoline.com/knowledge-center/derivatives/how-to-trade-in-futures-and-options
https://www.forbes.com/advisor/in/investing/how-does-trading-in-futures-and-options-work