What is a Future Option?
If you have recently started trading in the stock market, the chances are that you have understood its basics by now. Trading in the stock market basically includes buying and selling the shares listed on the stock exchanges (National Stock Exchange and Bombay Stock Exchange) to generate profits.
A general and straightforward way of buying/selling shares on the stock exchanges is known as the cash market. However, there is another method of trading in the stock market, called the derivatives market. This market is mainly preferred by experienced traders, who are well-versed with the stock market intricacies.
Futures trading and options trading are the two major types of derivatives trading in the stock market. Let's learn about futures and options in detail.
What are Futures and Options?
Futures and Options (F&O) are basically the contracts signed by two parties for trading a fixed number of stocks at a pre-determined price on a future date. An F&O trading contract awards the buyer a right to sell or purchase the underlying securities at a pre-determined price on the contract's expiry date, irrespective of the current market price of those securities.
For example, an F&O contract with one-month validity gives the buyer a right to sell or purchase the underlying stocks at the 'strike price' after a month.
Key Terms in Futures and Options Trading
Below are a few key terms related to futures and options trading:
Call Option – You can buy a call option if you expect the underlying securities' trading price to move higher in the future. Buying a call option will give you the right to purchase the underlying securities at the 'strike price' anytime before the expiry of your F&O contract.
Put Option – The put option is precisely the opposite of a call option. You can buy a put option if you expect the underlying securities' trading price to fall in the future. Buying a put option will give you the right to sell the underlying securities at the 'strike price' anytime before the expiry of your F&O contract.
Strike Price – This is the pre-determined price at which you can buy or sell the underlying securities of an F&O contract at a future date. You need to choose a strike price while buying an F&O contract.
Premium – This is the amount you need to pay for buying an F&O contract. The premium is decided as per the strike price of the contract. If the strike price is near the current market price of the underlying stocks, the premium is higher, and vice-versa.
Contract expiry – All F&O trading contracts come with an expiry date, and you are required to exercise your right before this expiry date. If you fail to exercise your right before the contract's expiry date, you will lose the premium price you've paid for it.
How to Go About Futures and Options Trading?
Future and Options trading involves buying and selling F&O contracts. You can take either a call option or a put option and pay the required premium to buy an F&O contract. The total premium you need to pay will depend upon the lot size of the contract.
Based on the market fluctuations, the premium price of your contract will keep on changing throughout its validity. You can then wait till the expiry date of your F&O contract to exercise your right or exit any time during its validity to book loss or profit.
The Parting Words
We hope you have a basic understanding of futures and options by now. If the market moves as per your predictions, you can make huge profits through F&O trading. However, if the market moves in the opposite direction, you can also incur significant losses. Therefore, it's prudent for you to gain adequate knowledge before starting to trade in derivatives.
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What Are Futures Contract?
Futures refer to derivative contracts that obligate the buyer and the seller to transact a stock, security, or commodity at an agreed-upon future price and date. It is also known as futures contracts. The agreements are legally binding. On expiry, it must be settled either in cash or by physical delivery.
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.
Futures & Options Trading and How to Make Money
Investing in futures and options comes with its risks. Most seasoned traders believe that you require a lot of funds to start futures and options trading. But some individuals have started small and earned fortunes. Therefore, it is your trading ability that makes all the difference.
Frequently Asked Questions
In options trading, the total amount you need to pay for buying an Option depends upon the lot size and the premium. You can multiply the total number of shares in one lot by the premium to calculate this amount. For example, if you're buying an Option of 1 lot containing 3600 shares at a premium of ₹3.50, you are required to pay ₹12,600.
In options trading, many factors go behind determining the value of the premium of an Option Contract. They include recent market trends, strike price selected, expiry date of the contract, the current market price of the underlying stocks, and the time decay (also called theta decay).
Futures and Options differ from each other in terms of the obligations imposed on the buyer. In futures trading, the buyer had to mandatorily follow up on the contract by its expiry date. Whereas, in options trading, the buyer has the right and not an obligation to follow up on the contract. They have the option to exit anytime during its validity.