Future and Options both are known as “derivative products”. A Future is an agreement to trade a underlying stock or other assets at a pre-decided price on a particular date. Then again, Options contract offers a chance to the financial investors the right however not the commitment to trade the assets at a particular cost on a particular date, known as the expiry date.
Future and options in the share market are contracts which derive their price from an underlying asset (known as underlying), such as shares, stock market indices, commodities, ETFs, and more. Futures and options basics provide individuals to reduce future risk with their investment through pre-decided prices. However, since a direction of price movements cannot be predicted, it can cause substantial profits or losses if a market prediction is inaccurate. Typically, individuals well versed with the operations of a stock market primarily participate in such trades.
Meaning of Future and Options in trading
Future and Option are two derivative instruments where the traders buy or sell an underlying asset at a pre-determined price. The trader makes profit if the price rises in case, he has a buy position and if he has a sell position, fall in price is beneficial for him. In the opposite price movement, traders have to bear losses. In the case of futures trading, a trader has to keep a certain percentage of the future value with the broker as margin to take the buy/sell position. To buy an Option Contract, buyer has to pay a premium.
Difference Between Future And Options
Future and options trading are different in terms of obligations imposed on individuals. While futures act a liability on an investor, requiring him/her to follow up on a contract by a pre-set due date, an options contract gives an individual the right to do so.
A futures contract to buy/sell underlying security has to be followed up on the predetermined date at a contractual price. On the other hand, an options contract provides a buyer with a choice to do the same, if he/she profits from a trade.
Future and Options Their Types
Options
An options contract is the right, and not the obligation, for its buyer to buy or sell the underlying asset at a certain price on or prior to a fixed date. Options are a good way to trade in stocks without owning them.
Types Of Options
- Call Options: A Call Option gives buyer/holder the right but not the obligation to buy specified quantity of an underlying asset.
- Put Options: A Put Option gives buyer/holder the right but not the obligation to sell specified quantity of an underlying asset.
Futures
Types Of Futures
- Financial Futures: Stock futures, Currency futures, Index futures, Interest rate futures and others
- Physical Futures: Commodity futures, Energy Futures, Metal Futures and others
Important terms in Futures and Options
- Strike Price: Strike price is a price at which the options contract owner agrees to buy or sell the underlying asset at the time of exercising the contract.
- Premium: Premium is the current price (or a fee) of an options agreement paid by the option buyer to the seller. It is quoted on the Exchange as a rule. The higher the volatility of the underlying asset, the higher the premium.
- Expiry Date: It is the fixed date by which the options must be exercised otherwise it will be expired.
Who Should Invest In Futures And Options?
Future and Options trading though have profit potential but also involves risk in it. This kind of trading may not be for everyone. F&O, both have their own pros and cons. There are different types of traders who invests in Future and options. Take a look on following
Hedgers
Hedgers are those who might get impacted due to price movement of a certain asset and so invests in a derivative contract to hedge of the risks involved with the price movements in an asset.
Hedgers aim to secure their gains or expenditures in the future by entering into a derivative contract. Such traders are popular in the commodity market, wherein individuals try to secure an expected price of a particular item for a successful exchange.
Hedgers primarily opt for physical trade wherein the asset is exchanged upon maturity of the contract. It is particularly popular in the commodity market, wherein physical trade is undertaken by producers and companies to keep the cost of raw materials at a fixed level. It ensures stability in the price levels in an economy
Speculators
Speculators people who invests in securities purely to take benefit of price fluctuations to draw profit.
Speculators predict the direction of price movement in a market as per an intrinsic valuation and economic condition and choose to take an opposite stance in the present to gain from such price fluctuations. Taking a futures and options example, if an investor predicts the price to increase in the future, he/she can assume a short position in the derivatives market. It indicates a purchase of a stock/derivative in the present to sell it on a later date, at a higher price.
Most speculators engaging in derivatives trading aim to opt for cash settlement, wherein the physical transfer of an asset is not conducted. On the contrary, a difference between spot price (current market price) and the price quoted to the derivative is settled between two parties, thereby reducing the hassles of such trade.
Arbitrageurs
Arbitrageurs are those who try to make profit from the difference in the prices of an asset due to market conditions.
Arbitrageurs aim to profit from price differences in the market, which arise due to market imperfections. A price quoted in futures and options trading includes the current price and cost of carry, along with an underlying assumption that a strike price matches the contractual price. Any price difference arises from carrying the underlying security to the future date, known as the cost of carry.
Way Forward
However, as explained above, Future and Options have high risks associated, as accurate predictions regarding the price movements have to be made. A thorough understanding of stock markets, underlying assets and issuing organisations, etc., have to be kept in mind to profit from derivative trading. You can read about Mutual funds. Don’t have Demat account. Click here.
Future and Options are subject to market risk. This is because there is no way to predict what will happen in the future or whether a given asset will increase or decrease in value. Because the market cannot be accurately predicted or completely controlled, no investment is risk-free. This is only for information.