BAJAJ BROKING
September 19, 2024
4 mins read
Futures and options are types of derivatives contracts. Their value is based on that of their underlying asset. For example, if you have an option on a stock, its value will rise or fall depending upon the value of that stock. Read more...
F&O should be used for risk management. However, some traders start buying F&O purely for speculating, which can be risky. Besides, futures and options are more complex than stocks and bonds. Hence, if you want to trade in them, you should understand all the complexities involved and only then start trading.Read less
Trading in futures and options (F&O) starts with understanding how derivatives work. These contracts derive their value from an underlying asset like a stock or index. You must open a trading account with F&O privileges and learn the basics of margin, lot size, strike price, and expiry. Futures allow you to lock in a price, while options give you the right (but not the obligation) to buy or sell. You can either hedge existing positions or speculate for potential profit. It is important to track price movements, evaluate historical trends, and stay updated on market news. Use trading platforms that offer real-time charts and data. Many investors start by paper trading to practise before committing real money. Once comfortable, you can begin trading by choosing a contract, entering the trade, and managing your risk through stop-loss and target strategies. Keep your goals clear and avoid excessive leverage.
Futures and Options (F&O) trading involves buying or selling an underlying asset at a predetermined price on a future date. These derivative instruments allow traders to profit from market movements without owning the actual asset. In futures trading, traders must maintain a margin with the broker to take buy or sell positions. In options trading, buyers pay a premium for the right — but not the obligation — to execute the contract. Understanding market trends, risk management, and contract specifications is essential for successful F&O trading.
However, trading in F&O requires you to have a brokerage account. Using this account with a broker, you can trade in future and options. In India, F&O on stocks are traded on stock exchanges like the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). Meanwhile, the F&O on commodities are traded through National Commodity & Derivatives Exchange Limited (NCDEX) and Multi Commodity Exchange (MCX).
Now that you have learnt how to trade futures and options, let’s delve deeper into this topic.
Futures and options might seem similar at first, but they operate quite differently. Futures are binding contracts where both parties must execute the trade on expiry. In contrast, options give you a choice. You’re not obligated to go through with the trade unless it suits your interest. Futures carry higher risk and reward, while options let you manage risk better through limited exposure. Futures require upfront margin, and losses can exceed the investment. Options, on the other hand, involve a premium that limits your loss to that amount. Futures are more straightforward but risky; options are more flexible and strategic. You can also exit both before expiry, but the cost structure and volatility impact vary. The purpose also differs—futures are mostly used for hedging and large-scale speculative bets, while options suit retail traders looking to play on price movement with controlled risk. Understanding these nuances helps you decide what fits your investment style best.
Futures and options are far more complex instruments than stocks and bonds. Hence, it’s important to understand their basics well:
A futures contract is a legal contract between two parties. Under this contract, one party has to buy/sell a certain asset from the other party at an already fixed price and on a specified date in the future.
In a futures contract, a buyer is legally obligated to buy an asset and a seller is legally obligated to sell it.
In an options contract, the buyer of an option has the right (but not an obligation) to buy or sell an asset at a predetermined price within a specific period.
If you buy a futures contract to buy an asset, you are under an obligation to buy it based on the terms of a contract.
However, if you buy an option to buy an asset, you have the option to buy it but not an obligation to buy it based on the terms of a contract.
Additional Read: ITM call option
You can trade in futures and options by following a step-by-step approach. First, you need to open a demat and trading account with F&O activation. Make sure the broker offers tools and resources for F&O trading. Learn how leverage and margin work before placing your first trade. Then identify the asset you want to trade and study its market trends. Choose between futures or options depending on your strategy—directional bets, hedging, or income generation. Place your order based on your analysis using the trading platform. Always use stop-loss and position sizing to manage risk. Monitor your trades actively, especially closer to expiry. You can square off your position before expiry or let it settle, depending on your goals. It’s also crucial to keep track of brokerage charges, as they can eat into profits. With practice, you'll become more comfortable navigating the volatility of F&O markets.
Investing in Futures and Options (F&O) requires strategic planning and knowledge of the market. Follow these steps and you’ll be well versed in how to trade in futures and options effectively:
Choose a broker registered with NSE or BSE that lets you trade in futures and options.
Futures trading requires a margin deposit, while options trading involves paying a premium.
Conduct thorough research using technical and fundamental analysis before placing trades.
In options trading, choosing an appropriate strike price is essential for profitability.
Keep track of option premiums and expiration dates while planning your trades.
Place orders to buy or sell futures and options contracts based on market expectations.
Use stop-loss and profit targets to limit potential losses when you trade in futures and options.
Monitor your contracts and exit trades before expiry to manage risk effectively.
By following these steps, you can successfully trade in futures and options while minimizing risks and maximizing gains.
In futures trading, the expiry date marks the last day a contract remains valid for trading. After this, it is either settled in cash or through the physical delivery of the asset. In India, futures contracts expire on the last Thursday of each month, as per stock exchange regulations. If this day is a holiday, the expiry moves to the previous trading session. Investors who trade in futures and options must manage their positions before expiry to avoid mandatory settlement. Expiry significantly impacts pricing and market volatility, making it a crucial aspect to monitor while you trade in futures and options. Understanding expiry helps traders plan better and make informed decisions in how to trade in futures and options effectively.
The primary objective of entering into a futures or options contract is to manage your risk. However, at times, traders take more risks by buying an F&O contract. So, keep these things in your mind:
While entering an F&O contract, you must keep the downside in mind.
If you have a future contract to buy a stock “X” on August 31 at a fixed price of Rs. 100, then you have to buy X at Rs. 100 on August 31. Even if the price of X falls to Rs. 80, you'll have to buy it at Rs. 100.
In the case of an option contract, you don’t have an obligation to buy X; however, you will lose your premium if the price of X falls below Rs. 100.
Just as in the case of other investments, even in the case of futures and options, the higher the risk, the higher the reward. So, you shouldn’t get attracted by only looking at the reward of an F&O. First, you should check the risk and if you’re comfortable bearing that risk, you should enter that position.
You should set up a stop-loss level or a take-profit level. A stop-loss order sells a contract at a fixed price to limit your losses. And, a take-profit order sells a position at a fixed price to book profits.
In a futures contract, the margin depends upon the volatility in the market. If the market is extremely volatile, you may have to deposit more margin with your broker. Otherwise, your broker may square off your position and you may lose your margin. So, always keep an eye on volatility.
Before diving into F&O trading, it’s important to be aware of key considerations. These points will help you reduce risks and make informed decisions as you trade.
F&O trading carries higher risk due to leverage. You can lose more than you invest if you don’t manage positions carefully.
Begin with small trades or paper trading. Understand how pricing, premiums, and margins work before scaling up.
Always set stop-loss limits to manage potential losses. This protects your capital during market volatility.
Stick to your trading plan. Don’t let greed or fear drive your trades. Discipline often separates good traders from the rest.
Market conditions change quickly. Keep yourself updated with news, earnings reports, and global events that may affect your trades.
Be clear on when your contract expires and how settlement works. Failing to exit in time can result in unexpected outcomes.
Brokerage fees and short-term capital gains tax apply. These can impact your net returns, so factor them into your strategy.
Some of the famous option trading strategies are explained below:
Covered call strategy: This is a famous option strategy. Under this, an investor buys an asset and then he writes a call option on it. This means he sells the right to someone to buy that asset from him at a predetermined price on a specific date.
Married put strategy: This is another popular option strategy. Under this, an investor buys an asset and buys a put option. The put option gives him the right to sell the asset at a predetermined price on a specific date.
Pullback strategy: When there’s a slight change (or reversal) in an existing trend of an asset’s price, traders can employ the pullback strategy. When there’s a slight dip in the price in an overall uptrend, traders can buy an asset, hoping that the price will go back to the original uptrend. On the other hand, when the overall trend is of a price decline, but there’s a momentary increase in price, traders can sell when the price increases a bit, expecting that the price will ultimately fall.
Spread trading: Under this strategy, traders buy and sell two futures contracts that are correlated at the same time. Their objective is to make use of the discrepancy in the price of these two futures.
If you’re thinking of opening a trading account, chances are that you’ve heard about futures and options. Bear in mind that futures and options should be used mostly for risk management. If you buy F&O purely for speculative reasons, you may lose a lot of money. Therefore, the first thing that you should do is understand their basics well. And then you should buy such contracts only if you need to.
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
For All Disclaimers Click Here: https://bit.ly/3Tcsfuc
Future and options are derivative contracts. Their value is based on the value of an underlying asset, which can be a stock or a commodity.
You don’t need a demat account to trade in futures and options. However, you need a brokerage account to trade in these contracts. Stock-based F&O are traded on the NSE and BSE. And, commodity-based F&O are traded on NCDEX and MCX.
The main risk is that the price of the underlying asset may not move in the direction you think. And in the absence of a stop-loss order, your losses can be huge.
First, learn the basics of futures and options. Second, open a brokerage account. Third, start with small amounts.
For option-trading, you can use these strategies: covered call and married put. For trading in futures, you can employ these strategies: pullback strategy and spread trading.
Budget 2024 has increased the taxes on F&O. The budget has increased the tax on futures transactions from 0.0125% to 0.02% of the traded price. Meanwhile, the tax on options transactions has been increased from 0.0625% currently to 0.1% of the option premium.
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