In this article, we will discuss
- What Is F&O (futures and options) Trading?
- Types of Future Contracts
- Types of Option Contracts
- Who Should Trade in Futures & Options?
- F&O Trading Based on Multiple Asset Classes
- Final Words
- Frequently Asked Questions
Derivatives are contracts between two parties which derive their value from an underlying asset such as stocks, indices or commodities. The four main types of derivatives include forwards, futures, options and swaps. While forwards and swaps are traded over the counter, futures and options are traded on stock exchanges and can be used by anyone.
These financial instruments offer new ways for traders to manage their assets. Derivatives like futures and options are used for hedging a position, speculating on an asset’s price changes or for increasing leverage.
Read along to get more insights on F&O trading, types, asset class-specific insights and much more.
What Is F&O (futures and options) Trading?
Futures and options are a form of derivatives which are traded on stock exchanges and used by traders to take a position on the movement of asset prices.
These financial instruments enable individuals to speculate on the future prices of various assets such as stocks, indices, currencies and commodities. Essentially, these contracts facilitate the trading of underlying assets at a predetermined price on a specified date.
In simple terms, futures and options are contracts, where two parties bet and take a position on the future price of an underlying security. The purpose of these contracts is to mitigate the market risks associated with trading by fixing the price in advance.
A futures contract is an agreement between the buyer and the seller which obligates them to buy/sell an underlying asset at a specific price on a specified date. On the other hand, options are agreements between a buyer and seller which give the buyer the right but not an obligation to execute the transaction at a predetermined price within the expiry date.
It’s important to note that stock price movement can never be forecasted with surety. Hence, there are chances of significant profits or losses, when market predictions are accurate and inaccurate. Generally, individuals with a deep understanding of stock market operations are the main focus of F&O trading.
Types of Future Contracts
Future agreements are of mainly five main types which are as follows:
Stock Futures
NSE introduced index options from 2000 and 2001 which were linked to the NIFTY 50 index for investment and trading purposes. Subsequently, the NSE introduced single stock futures and options on company stocks listed on the stock exchanges. Stock futures allow investors to take long or short positions on a stock without having to buy it. They can be used to speculate on price movements or for hedging.
Currency Futures
Currency futures involve contracts where the underlying asset is a currency pair. Here, sellers and buyers are allowed to buy or sell one particular currency at a predetermined rate against another currency, such as the USD against the Rupee, at a specified date in the near future. In India, four currency pairs are available forF&O trading- USD/INR, GBP/INR, JPY/INR and EUR/INR.
Index Futures
Index futures are a type of futures contracts which consist of an index as an underlying asset. In case the investors or traders are looking forward to speculating on investments such as Sensex, nifty etc. However, in India, there are several other varieties of futures contracts such as Nifty 50, Sensex, nifty bank, nifty IT etc. which act as an underlying asset for such contracts.
Commodity Futures
It is a type of future contract which allows the investors to hedge against the price in commodity prices. The underlying commodities can include gold, silver, oil, petroleum and agricultural products. Moreover, speculators can strategically employ these types of futures to speculate its price movements.
Interest Rate Futures
It is a type of future contract which is linked to a debt instrument which serves as an underlying asset, such as a government bond or treasury bill. Moreover, these are tradable on both the NSE and BSE.
Types of Option Contracts
There are two main types of option contracts, which are:
Call Options
The buyer or holder of a call option receives the right but not an obligation to buy a certain quantity of an underlying asset on or before the date of expiry.
Put Options
The buyer or holder of a put option receives the right but not an obligation to sell a certain quality of an underlying asset on or before the date of expiry.
The underlying asset of options contracts can be stocks, commodities, currencies or indices, just like with futures.
Who Should Trade in Futures & Options?
Though trading in futures and options has high-profit generation potential, it has a significant amount of risk in it. Hence it is advisable to start F&O trading only if you have a good amount of market experience.
The following are the types of market participants who take part in futures and options trading:
Speculator:
Speculators in simple words are expert traders who are capable of predicting asset price movements with a fair amount of accuracy. Based on their speculation, these traders buy or sell futures and options with a long or short position.
Arbitrageurs:
Arbitrageurs are traders who aim to make profits from the price differences of various assets. They can also trade options and futures in order to leverage the volatile market condition by making lucrative gains.
Hedgers:
Hedgers are those individuals who buy or sell physical commodities or take the delivery of stocks in order to mitigate their risk. They mitigate risk by betting in the opposite direction to a large position they already have.
Factors to Consider While Trading in Futures and Options
Here are some of the factors which you must consider trading in futures and options.
Observing the Volatility and Its Effects:
Observing themarket volatility and price fluctuation along with its effect on the F&O pricing enables you to assess the volatility level, indicator usage and its impact while selecting trading strategies
In-depth Market Research and Analysis:
At the time of making an entry, it is crucial to analyse the market thoroughly and conduct in-depth research on it. This includes understanding the market trends, fundamentals, and historical data and keeping yourself updated on the current developments and news coverage.
Being Aware of Time Decay:
Both futures and options come with a date of expiry and with time the value of these contracts decreases as the expiry date comes closer. This phenomenon of value reduction is known as time decay. Hence, consider the time decay factor while planning your trades.
F&O Trading Based on Multiple Asset Classes
Here are some of the F&O trading practices based on various asset classes:
Trading with Index Futures
Index futures are the type of stock futures which allow a seller or a buyer to buy or sell a specific index at a specific price which is also known as strike price. It also enables you to buy a specific quantity of indices at a specific price in future.
Here are some of the types of index futures include: Nifty 50, BSE Sensex, Nifty Bank, BSE Sensex 50, BSE Bharat 22 Index, Nifty IT, etc.
Trading with Commodity Options
Commodity options are contracts which give the rights to buy or sell (buy: call option, sell: put option) the underlying commodity futures at a specified price on the contract expiry date. However, please note that commodity trading works in a bit different way to equity options trading as traders cannot directly speculate on commodities.
Here are some of the types of commodities in the stock exchanges as commodity derivatives: Gold, Copper, Silver, WTI Crude Oil, Aluminium, Lead, Nickel and Zinc.
Final Words
Hopefully, by now you have got an overall clarity on F&O trading and with respect to specific asset classes. Though they have the potential to leverage market volatility and generate lucrative gains, futures and options come with a high-risk factor. Hence, it is always recommended to invest or trade only if you have enough exposure or experience in the stock market.
If you are willing to start your F&O tradingjourney, you can consider signing up for the Samco Trading App. It provides you with a clean and feature-loaded trading interface for a smooth trading experience.
Frequently Asked Questions
1. Is F&O trading profitable?
Ans. Yes, F&O trading can be profitable, its margin-based trading attracts the majority of the traders and a high-value position can be secured just by paying a small amount in the form of a premium.
2. What is the difference between option and future trading?
Ans. The primary difference between options and futures is that options give the right and do not have an obligation to the contract buyer to buy/sell an underlying asset at a predetermined price and within a specified date. On the other hand, futures are contracts which obligate the contract buyer to buy/sell an underlying asset within a specified price and date.
3. How do I choose stocks for F&O trading?
Ans. The most crucial rule of stock selection is to focus mainly on the highly liquid F&O only, as there is a time shortage while making selections. It also makes sense to choose companies with upcoming events that could push the price in a predictable direction.
4. Which are safer- options or the future?
Ans. Choosing one among the two can be a bit difficult as both futures and options carry an equal amount of risk associated with them. As these are leveraged investment options, the magnitude of either profit or loss can be high. However, futures carry an obligation for the contract buyer; hence, they can be considered riskier.
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