In the fast-paced world of the stock markets – where prices change within the blink of an eye – investors often look for ways to manage risks and maximise returns. Among several tools available, Futures and Options (F&O) stand for their versatility and potential to generate significant profits with minimum investment.
At its core, options and futures are derivative instruments which derive their values from underlying assets, such as stocks, commodities, and currencies. F&O trading involves betting on the direction in which a particular asset’s price will move.
Understanding the basics of FnO trading is crucial for anyone looking to enter this dynamic market. Both tools can be powerful when used correctly, but they also carry significant risks if misunderstood.
This blog aims to explain the fundamentals of futures and options market while also providing examples that beginners like you can easily grasp. You will also explore the futures vs options differences, and learn how you can invest in these instruments through FnO trading app. Keep reading.
What Are Futures and Options?
Futures and Options (F&O) are financial derivatives that derive their value from an underlying asset, which could be a stock, commodity, currency, or index. Unlike traditional stock trading, where you buy or sell shares of a company, F&O trading involves buying and selling contracts that give the buyer the right (in the case of options) or the obligation (in the case of futures) to buy or sell a particular quantity of an underlying asset at a pre-determined price on a specific date.
Futures and options trading allows individuals to mitigate future investment risks by locking in pre-determined prices. However, because price movements are unpredictable, incorrect market predictions can lead to significant gains or losses. Thus, F&O trades are typically undertaken by investors who have a deep understanding of stock market operations.
Futures vs Options Difference
While both futures and options seem similar, they are two distinct derivative instruments. Futures are contracts where the buyer agrees to purchase, and the seller agrees to sell an asset at a predetermined future date and price. Both parties are obligated to fulfil the contract upon expiration, regardless of the market price of the asset at that time.
On the other hand, options give the buyer the right but not the obligation to buy (call option) or sell (put option) the underlying asset at a specified price before or at the expiration date. The buyer of the option pays a premium to the seller for this right, and if the market moves in their favour, they can exercise the option for a profit. In the case of adverse market movement, the buyer can choose not to exercise their right and let the options contract expire.
What is Option Trading?
Options trading is a financial strategy that involves buying and selling contracts with an aim of generating profits. It allows you to take advantage of price fluctuations in an asset without actually owning that asset. You can simply buy a call option (if you feel that the price of the underlying asset could go up in the future) or a put option (if you feel that the price of the underlying asset could decline in the future), and then sell it again at a higher (or lower) price before the expiration date. Like regular shares, options contracts can be purchased or sold on the stock exchanges.
Why Do We Do Options Trading In Stocks?
Stock options trading provides flexibility to manage risk and potentially increase your profits. You can use stock trading options for hedging, speculation, or profit generation.
Hedging: Hedging allows you to protect your stock investment portfolio against downside risks. For example, buying a put option allows you to sell particular stocks at a predetermined price, thereby limiting your losses if the stock price falls.
Speculation: As an options trader, you can speculate on the future price movement of stocks. If you believe a stock will rise, you can buy call options to profit from the increase. Conversely, if you expect the stock price to drop, you can purchase put options.
Profit Generation: Selling options can generate profits through the premiums received from buyers. However, it also carries significant risks of incurring losses.
What is Call And Put Option in Future And Options?
As mentioned earlier, a call option gives the buyer the right to buy an asset, while a put option gives the buyer the right to sell an asset at a pre-determined price on or before a specific date. Let’s understand this better with the help of a future and options example for beginners:
Case 1:
Assume a stock is trading at ₹100. You buy a call option with a strike price of ₹105, expiring in a month, for a premium of ₹5. Now, if the stock price rises to ₹110 before the expiry date, you can exercise your call option and buy the stock at ₹105, making a profit of ₹5 per share (₹110 – ₹105). Your total profit would be ₹5 (stock price appreciation) minus ₹5 (premium paid), equaling zero. However, if the stock rises to ₹120, your profit would be ₹10 per share after subtracting the premium.
Case 2:
Suppose the same stock is trading at ₹100, and you purchase a put option with a strike price of ₹95, paying a premium of ₹3. If the stock price falls to ₹90, you can exercise your option to sell the stock at ₹95, making a profit of ₹5 per share (₹95 – ₹90). After subtracting the premium, your net profit would be ₹2 per share.
How To Trade Future Options?
In India, future options trading takes place on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). F&O stocks are specific stocks on which futures and options contracts are available for trading. Stock exchanges determine the list of eligible FnO stocks based on various criteria, including liquidity, market capitalisation, and trading volumes.
If you wish to make futures and options investments, you will need to open free Demat account with a registered stockbroker. Several FnO trading app also allow futures derivative trade on stock exchanges, making trading FnO easier for beginners.
To Conclude
Futures and options trading provides an opportunity to protect your portfolio against downside risks and also generate significant profits. However, you must approach with caution and gain a solid understanding of market fundamentals before venturing into the world of FnO trading.
FnO app and online trading platforms such as HDFC Sky make trading FnO easier with real-time data, analytical tools, and seamless transaction processing, among other facilities. Click to know more.