Future and Options – a beginner’s guide
Options are derivative contracts that are traded in the share market, just like Futures. They obtain their value from some underlying assets hence they are termed derivatives. The contract happens between two parties who buy or sell derivatives on a future date at a predetermined price. The objective is hedging risk due to market fluctuations by securing the price of the asset on a fixed date. One investor assumes the prices will fall whereas the other anticipates the opposite. They both enter the contract with an assumption and make a profit/loss as the market performs.
How future and options are different?
In simple terms, a future is a derivate contract that allows the investor to buy/sell the underlying assets at a predetermined rate on a future date. Conversely, an option is a contract that gives the option or right to the investor to buy/sell the underlying assets at a fixed price on a certain date. The specific date is termed the “expiry date” of the contract. Thus, in futures, the investor has the obligation to buy or sell the assets, unlike options. Future and options are different from stocks or commodities as they don’t have an intrinsic value. Also, they are not traded directly in the stock market and hence are less affected by price fluctuations.
How do I trade options?
The first step is to choose a broker who has a reputation and enough experience in options trading. Next, you need to have an F&O activated Demat account and open a trading account in a reputed online trading app and MO Investor app.
In options trading, the buyer selects the “strike price”, and pays a premium to the seller. Whereas the seller of the contract pays a margin when he agrees with the contract. The strike price is the price of the asset at which the buyer and the seller agrees to settle the contract at the expiry date.
Options are divided into two contracts: “Call” and “Put”. With a “Call” option the buyer gets the right to buy the assets at a predetermined rate in the future. On the other hand, with a “Put” option, the buyer gets the authority to sell the asset in the future at a fixed rate.
There are several strategies involved with options trading but the most basic strategies for beginners are long calls, long puts, covered calls, etc.
Is Option trading safe?
F&O trading involves certain risks but since these are leveraged instruments, the extent of profit and loss are also limited. Thus, investors who have previously incurred losses from the equities market and want to hedge risks may opt for F&O trading. One disadvantage in options trading is the upfront premium you need to pay while entering the contract without any guarantee of returns. On the other hand, it gives you the advantage to hedge potential market risks with leveraged returns and downside protection. However, the investor should do his best to learn and gain experience to be successful in options trading. There are several strategies to be successful as an options trader. Your financial advisor and broker can take an important role in helping with new sure-shot strategies to make profits.