To understand Futures and Options, it is important to have an understanding of Derivatives. In the financial markets, a Derivative is a contract that derives its value from underlying assets. These assets can be stocks, bonds, gold, currencies, market indices, commodities, etc. When you buy a derivatives contract, you earn profits by estimating the future price of the asset(s). There are four types of derivative contracts:
Futures are Derivatives contracts in which both buyers and sellers have the obligation to buy/sell the underlying asset at a predetermined price respectively. A Futures Contract is an agreement between the buyer and the seller to buy or sell a specified quantity of the underlying asset at a future date at a price agreed upon between them. Hence, at the expiration date, the buyer must buy and the seller must sell the agreed quantity of the asset at the set price regardless of the current price of the asset. Further, these contracts are marked to market every day. In other words, the contract value is changed every day until the expiration date. They are traded on exchanges just like stocks.
Options are Derivates contracts that offer the buyer the right (but not the obligation) to buy/sell the underlying asset at a predetermined price. The buyer can also choose to allow the Option to expire. The seller has an obligation to execute the contract. They are traded on exchanges just like stocks. An Option contract has four elements:
There are two types of Options contracts:
Strike Price is the price at which the Option contract can be executed.
The Expiration Date of an Option is the last date by which the owner of the contract can exercise the right to buy or sell the underlying asset. In India, monthly Options Contracts expire on the last working Thursday of the month. If that day is a market holiday, then the Option expires on the previous working day. In the case of weekly Options, the contract expires every Thursday
There are various factors that affect the calculation of the premium of an Options Contract:
All Options that have a Stock Market Index as the underlying are Index Options. This allows investors to trade on the entire market instead of individual securities.
An American Option is an Options contract that can be exercised on or before the expiration date. Options on individual stocks are American Options. A European Option is an Options contract that can be exercised only on the expiration date. Index Options are excellent examples of European Options.
You can buy/sell Options contracts through broking firms that are registered members of the BSE or NSE. These brokers provide online platforms and/or mobile applications allowing you to trade in Options at will. Before opening an account, ensure that the broker offers Options trading and supports all kinds of Options like equity, currency, commodity, etc.
There are different strategies followed by investors while trading in Options.
These are terms that signify the position of the strike price of the Option compared to the current price.
If the current price equals the strike price, then the Option is said to be At The Money or ATM.
When you are looking at an Option, assess the underlying asset(s) and try to estimate the direction its price might take in the coming month.
In these cases, you can consider BUYING a Call Option or SELLING a Put Option as it will put you in a position to earn profits.
In these cases, you can consider SELLING a Call Option or BUYING a Put Option as it will put you in a position to earn profits.
There are many differences:
In India, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are Options trading exchanges.
Trading in Options offers a range of benefits including:
Options contracts with a maturity of up to three years are called Long Dated Options. While the features of these Options are the same as the monthly Options, they offer certain benefits like:
When you buy an Option, you will incur the following costs:
Here are some common types of Futures Contracts:
Here are some differences between Options and Futures Contracts:
Like Options, most Futures Contracts are settled in cash. The final settlement price is the closing price of the underlying asset.
Yes. You need to pay the Initial Margin before taking the position – upfront. Also, the outstanding positions in Futures are marked-to-market every day. Hence, you might be required to pay the MTM Margin to the broker too.