What is Futures and Options Trading?

What is Futures and Options Trading

What is Futures and Options Trading?

Table of Contents

What are futures and options trading? There are many types of trading products available in the market. People choose them according to their trading style or their risk appetite, and more. Futures and options are also one of these products. They are called derivative products basically. The futures and options trading falls under the category of stock derivatives trading in the stock market. 

Markets associated with the two derivative products generally have high liquidity and comparatively have better chances to make a profit, but investors need a higher amount of funds to invest in futures and options. So it would be good to make an informed trading decision. 

Difference between Futures and Options

A future is a derivative contract to buy or sell the underlying asset at a pre-defined price and the date. On the other hand, an option is a derivative contract that provides the right but not the obligation to buy or sell the underlying asset on a specific date or expiry date at a pre-defined price. 

A futures contract to buy or sell underlying security must be followed up on at a predetermined date at a contractual price at the market value. However, if a buyer makes a profit on a sale, an options contract allows them to do the same.

Difference between Futures and Options

Futures and options trading are dissimilar in terms of the requirements placed on traders. As the price of the underlying asset moves, more money must be deposited into the trading account to meet daily obligations. Gains on futures contracts are marked on a regular basis. Furthermore, while futures contracts impose a burden on investors by requiring them to finish a deal by a certain deadline, options contracts allow an individual to do so at their discretion in the investor’s account.

As a result, at the end of the trading day, the change in the value of the holdings, whether positive or negative, is credited to the individuals’ futures accounts.

Types of Options

Call Option

A call option gives you the option to buy underlying securities at a given price and within a certain time frame.

The amount you pay is known as the striking price. The deadline for exercising a call option is the expiry date in the securities markets. Financial contracts that give option buyers the right but not the obligation to acquire a bond, stock, commodity, or other instrument or asset at a certain price within a specified time period are known as call options. 

Put Option

An Options Contract gives the owner the right but not the obligation to sell a portion of the underlying asset at a certain price within a specified time frame, which is commonly referred to as a Put option.

A put gives the owner the option, but not the obligation, to sell the underlying stock at a certain price within a set time frame. As the underlying stock price falls, the put option’s value increases; as the underlying stock price rises, the put option’s value decreases. When a trader buys a put, s/he is betting that the stock futures will lose value.

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Futures and options trading

The first step is to register with a broker for a futures and options account. Because futures and options are only valid until their expiration date, they do not require a Demat account. As a result, they look more like contracts than assets.

Because you’re dealing with premiums, trading future options is a little more challenging. Futures and options are significantly more difficult than investing in stocks, so you’ll need to brush up on your knowledge.

Monthly contracts are used for trading options and futures. There will be just one Futures price for an asset in each contract. Trading futures options at a Futures price is usually more expensive than trading them at a spot price because of the time value. As a result, different strike prices for call and put options will be substituted for the same asset.

Traders use futures and options to hedge against the loss of their present investments and to prevent the dangers that come with significant market volatility. However, if the market goes in a favorable direction, traders may suffer huge losses in futures and options trading.

Futures are leveraged instruments with the ability to trade both ways. Purchasing options carries a modest level of risk, but profits are uncommon. Physical transactions, in which the asset is switched at the contract’s maturity, are preferred by hedging traders. It’s common in the commodity market, where manufacturers and businesses engage in physical trading to keep raw material costs consistent. As a result, it assures that the price levels of an economy stay steady.

Many traders believe that buying futures has an advantage over buying shares on the open market since they can use margin to leverage their transactions. These margins may, however, increase during moments of severe volatility. When trading futures and options, it is usually advisable to utilize stop losses and profit targets. This category includes all leveraged positions.

Keep an eye on the fees you’re paying for futures and derivatives. These assets fluctuate more frequently than equity assets, despite the fact that they are smaller in percentage terms. These charges vary according to various factors, and generally, traders pay brokerage fees on trading futures and options.

Important trading strategies

Covered Call Strategy

In this options trading approach, you buy underlying security in the spot market and sell a call on the same asset. Investors with a neutral to upbeat outlook employ this method. In terms of the risk-to-reward ratio, the profit is restricted, but the losses are possibly limitless. Furthermore, volatility may make things even harder for a trader who makes money using this strategy.

Forward trading

A transaction in which a buyer and seller commit to exchange a financial asset at a pre-defined price at a future date is known as forwarding trading. The stability of the underlying asset, as well as the contract on the asset price and trading date, define the value of a forward contract. Forward trading is a method of avoiding paying the spot price for a commodity.

Pros and Cons of Options and Futures 

Pros and Cons of Options and Futures

Pros

  • Trading options and derivatives are cost-effective because they come with a lot of leverage. Futures contracts can help risk-averse investors. Investors get access to markets that they would not have had otherwise. Purchasing an option is much less expensive than purchasing an asset outright. Futures usually start the day at a different price than they concluded the day before.
  • Traders can wager on the futures price moving in the same direction as the underlying asset price in the market. In options, the value of assets decreases over time, reducing the trader’s profitability dramatically. Time decay is the term for this. A futures trader is unconcerned about time decay. Traders can now come in and out of the market at any time.
  • Options traders pay less to trade than stock traders, but if the deal goes their way, they profit just as much as the stock trader. Liquidity is abundant in most futures markets, particularly those for currencies, indices, and commonly traded commodities. All contracts must be closed before the end of the day when trading futures, and no positions can be kept overnight.
  • Trading options and futures would produce significantly greater gains than buying stocks with cash. As a result, if the strike price is chosen right, the option pays the same profit as buying shares directly. If your forecasts about the time frame and direction of a stock’s journey are incorrect, your losses are determined by the amount you paid for the contract plus trading charges.
  • The percentage return will be much higher because we may be able to get lower margin options while retaining the same profitability. If you buy a put or call option, you are not obligated to execute the trade.
  • Traders utilize futures contracts to shield themselves from price declines in the futures market. Market volatility increases the chances of surprise losses or profits when holdings remain on the list at the end of a trading period.
  • In the options market, there are various options trading methods. In a short period of time, day trading can educate you a lot about the futures markets. Many people utilise forward contracts to manage their risk better. Businesses frequently use these contracts to reduce the risk of foreign currency conversion.
  • The transactions can be combined to construct a strategic position by using call and put options with different expiries and strike prices. Day trading futures contracts, in essence, allow one to swiftly obtain trading experience and information.

Cons

  • Because some stock options have less liquidity, traders will find it more difficult to enter and exit deals. When you write a put or call option, keep in mind that you are obligated to buy or sell shares at a predetermined price within the contract’s time window, even if the price is unfavorable. An option writer, unlike an option buyer, can lose far more money than the contract price.
  • Options are more expensive to trade than futures or equities. Some budget brokers, on the other hand, allow traders to trade with lower commissions. Most full-service brokers, on the other hand, charge a higher commission for trading options. A day trader must keep great discipline in order to be successful. The prospect of making marginal transactions and overtrading in futures markets is always present.
  • By executing a contract, investors potentially lose price advantages if the price falls faster than expected at the time of settlement. One of the most glaring drawbacks of futures trading is that traders have no control over what happens in the future.
  • The vast majority of folks who practice day trading futures lose money. Their failure was primarily due to a lack of planning and discipline. Options and derivatives trading is a game that takes a great deal of patience.

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Bottom Line

When trading futures and options, traders should be aware of the dangers involved. Due to their enormous liquidity, they are exposed to significant dangers. F&O trading is one of the best ways to protect your present investment from prospective losses through options and futures contracts.

In comparison, there are several ways to profit from future purchases. Even in the case of favorable market conditions, considerable losses can occur.

The ease with which you can trade futures and derivatives is largely determined by how well you select your broker. Investby, InvestFW, ABinvesting, and Capitalix are online brokerage services, that is known for offering an ideal environment for efficient trading at low costs.

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