How to Trade in Futures and Options: Beginners Guide Online | Espresso

How to Trade in Futures and Options?

Futures and options trading was introduced in Indian stock exchanges in 2000. Futures and options are known as derivatives because they derive their value from an underlying asset. However, the two are not the same. Futures trading differs from options trading in some ways.

 

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Let’s find out how futures trading and options trading differ and how you can trade in either or both of them.

What are Futures, and How does Futures Trading Work?

A futures trading contract or futures contract is a contract between two parties – the buyer and the seller. This contract permits the buyer to purchase a commodity at a pre-fixed price on a specific date in the future. The seller too agrees to sell the commodity at the pre-determined price to the buyer. Regardless of the change in the actual price of the commodity, the trade is carried out at the pre-determined price.

So, if the actual price rises, the investor makes a profit and if the price drops, the investor incurs a loss. There is an expiration date for every futures contract. This is the day the contract ends, and so the underlying commodity must be bought before or after the expiration date.

You do not have to wait till the expiration date to execute a transaction. You can also do so before the expiry if the prices move according to your expectations and you are able to earn a profit.

Let’s consider this example to understand future trading better:

Consider a scenario where you create a futures contract to buy 100 shares of ABC at the cost of ₹50 each at a certain date in the future. On the day of the trade, the price of the ABC share increases to ₹80. In this case, you will make a profit of ₹30 x 100 = ₹3000. However, if the price drops to ₹20 instead, you will end up with a loss of ₹3000.

Future trading in India can be done on two exchanges only – MCX (Multi Commodity Exchange of India Limited) and NCDEX (National Commodity and Derivatives Exchange Limited). You can trade futures contracts like silver futures, gold futures, crude oil futures, currency futures, bond futures, stock index futures, interest rate futures, etc.

What are Options, and How does Options Trading Work?

An option is a lot like a futures contract, but there is no obligation to buy or sell the underlying commodity in the future. In an options contract, the buyer may buy the asset at the pre-determined price in the future or let the contract expire.

The choice lies with the investor and can be exercised as per the price movements. The buyer also has to pay a premium in an options contract. So, if the prices do not move in your favour and you do not execute the trade, the only loss you make will be the premium paid.
Also Read: Best Options to Trade

There are two types of options in options trading:

  • Call option: With this type of option, you can purchase an asset at the pre-fixed price before or on the expiration date. This is ideal if the price moves up, so you can make a profit.
  • Put option: With this type of option, you can sell an asset at the pre-fixed before or after the expiration date. This is suitable when the price is expected to fall.

In either of the options, there is no obligation to execute the trade. You can take a call according to your judgement and needs.

To conclude

Futures and options trading can offer great growth opportunities to investors. But they are also volatile and susceptible to fluctuations. They carry high risk, and you need appropriate knowledge and experience to make accurate price predictions. So, ensure that you make a prudent investment decision while trading or seek expert advice before you put in any money.

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Frequently Asked Questions

Yes, you can legally trade in foreign options from India. However, you can do so only if you have an account with a foreign broker or an overseas trading account with an Indian broker.

The margin, also known as the premium, is the money that you pay the broker or seller. Regardless of whether you execute a trade or not, you have to pay the margin in an options contract.

The expiry date marks the end of the contract. Contracts are usually created for a period of 2 to 3 months, after which they end. On the expiration date, the contract is either settled in cash or by shares. However, you do not have to wait till the expiry date to execute a trade.

In futures, the buyer and the seller are obligated to execute the contract by the expiration date. However, in options, there is no such obligation. But the buyer does have to pay a premium in the case of options. There is no premium charged in futures trading.