Futures and Options (F&O) trading is an exciting segment of the stock market that allows traders to hedge risks, speculate on price movements, and leverage their capital. Let’s break down the basics of F&O trading, how it works, and key points to keep in mind before trading.
Futures
A futures contract is a promise between two parties to sell or purchase an asset at an agreed price on a future specified date. They are standardized and exchanged on markets. Futures are usually applied in hedging or speculation.
Example : Let’s say a trader anticipates that the price of Nifty 50 will go up in the coming month. They can purchase a futures contract at the current price and sell it sometime later when the price goes up, making a profit.
Options
Options are derivative instruments that provide the buyer with the right, but not the obligation, to purchase or sell an underlying asset at a specified price on or before the expiration date.
Types Of Options
Call Option: Provides the right to purchase the asset.
Put Option: Provides the right to sell the asset.
Example: If a trader purchases a call option of Reliance at ₹2500 with a one-month expiration and the stock price goes up to ₹2600, they can purchase at ₹2500 and sell at ₹2600 for a profit.
Futures VS Options
| Feature | Futures | Options |
|---|---|---|
| Obligation | Buyer & Seller must fulfill the contract | Buyer has the right, but not obligation |
| Risk | Higher, as it involves commitment | Limited to premium paid for buyers |
| Leverage | High | Moderate |
| Expiry | Fixed | Fixed |
| Use Case | Hedging, speculation | Hedging, speculation, income generation |
Risks in F&O Trading
1.High Volatility: F&O trading has price movements that can result in huge losses.
2.Leverage Risk: Leverage enhances profit potential but also amplifies losses.
3.Time Decay in Options: Options lose value as time to expiry approaches due to time decay.
4.Liquidity Concerns: Certain contracts might be less liquid, and it might be hard to close positions.
Essential Tips for F&O Traders
Learn the Market: Learn about market trends and the working of derivatives before trading.
Apply Stop Loss: Always use a stop loss to control risk and prevent undue losses.
Employ a Strategy: Don’t do random trading; employ strategies such as straddle, strangle, and iron condor.
Watch Open Interest: Open interest can reflect the mood of the market and potential trend changes.
Avoid Overleveraging: Invest only a small part of your capital in F&O trading to avoid huge losses.
Conclusion
Futures and options trading can be an effective tool for investors and traders if utilized judiciously. Although it provides possibilities to earn huge profits, it also has risks that must be managed with great care. Newbies must begin with sound research, paper trading, and discipline to achieve success in the domain of F&O trading.