Futures and options are agreements to buy and sell assets at specific prices sometime in the future under certain conditions. They have become very popular in the stock market in the past few years due to the advantages they offer.
Futures and options get their value from an underlying commodity or asset and are traded in the share market.
Since they are derived from such commodities, they are also called derivative products. They are a type of contract between two parties for trading stock or index at a specific price sometime in the future.
These twin derivatives protect you against future fluctuations in the stock market by specifying the price of the trade. You can look up online futures trading solutions to help you get started with the journey of derivative trading. There are many future trading software that can help you with the same.
Differences between Futures and Options
Futures and options are an outgrowth of the commodity market which necessitates understanding them in the latter’s context.
They do not bring you any long-term profits. Instead, they are used to offset risks that can happen due to the constant fluctuations in prices.
There is one difference that separates them both.
In futures, it is compulsory for the contract holder to buy the asset on a specific date in the future. Options give the contract holder the option or choice of execution of the contract which explains the name.
1. Commitment vs right:
As mentioned above, you are required to be committed to exercising the contract on a specific date with futures. On the other hand, options give you the right to exercise the contract. You are not obligated or compelled to exercise the contract with options
2. Date of Trade:
In futures, there is a specific date for the execution of a trade. The contract holder must trade the security on that date itself. In case of options, you can exercise some of your options until the expiration date.
3. Fluctuation in value:
In futures, there are less volatile price changes. Whereas in options, value declines over time at a faster rate. It fluctuates more widely with changes in the value of the underlying asset or commodity.
4. Risk:
Since you have the choice to exercise the trade-in options, you have more freedom to opt out of it as well. When it comes to futures, the trade must take place on a specific date regardless of the price.
Thus, we can say that in theory, options reduce the risk of loss since you can opt-out of exercising your options. However, practically most options expire without any trade. Hence option traders are more likely to lose their premium.
Types of Futures and Options
There is only one primary type when it comes to futures. They are fundamentally uniform with the same rules for both buyers and sellers.
On the other hand, options can be of two types:
Call option: This type of option allows you to buy an asset at a fixed price on a specific date.
Put option: A put option allows you to sell an asset at a fixed price on a specific date.
The trade is optional in either case. It is up to you to use your call or put option if the prices do not suit you.
How to invest in Futures and Options?
A Demat account is not a necessity for you to do futures and options trades. The best way to start derivative trading is to allow a broker to trade on your behalf.
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Trade in derivatives at the stock market:
You can start derivative trading at the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
The NSE lets you trade in derivatives in over 100 securities and nine indices.
Futures move faster than options since the former sees more leverage. In typical futures and options transactions, the traders pay what is the difference between the contract price and the market price. Therefore, you do not have to pay the actual price of the underlying commodity or asset.
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Derivative trading in commodities:
Futures and options trading is most commonly seen in markets like National Commodity and Derivatives Exchange Limited and Multi Commodity Exchange (MCX).
These markets are highly volatile. Futures and options allow traders to safeguard against a future price fall since the prices of commodities can fluctuate heavily.
Who Can Invest in Futures and Options?
Futures and options are most commonly used by Hedgers and Speculators:
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Hedgers:
Hedgers insulate against future price volatility. They are usually found in the commodity market where there are heavy price fluctuations. Derivative trade provides the needed stability in such cases.
Hedgers hedge their bets in a dynamic market and secure returns on the underlying asset.
But if the price increases in the interim, then they can lose out on the profit. When buying assets, they do so at a fixed price regardless of their market value.
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Speculators:
Speculation is an important element when it comes to derivatives trading. While hedgers bet to look for a stable price, speculators bet against the long odds.
A speculator analyses the market and news events that can affect trading and make a calculated guess at the prices.
They usually look to buy at low prices in the short term while speculating for higher returns in the long run.
Conclusion
Since derivative trading doesn’t require a Demat account, it is commonly seen as a cost-effective alternative.
There are additional costs and taxes involved but the real cost hike is due to the frequency of trades. Hence you should keep an eye on the number of transactions you are engaged in.
Trading futures and options are easy but it does require some understanding before you get started with it.
You can use derivative trading to save you from market volatility as a hedger. Being a speculator, you can make outsized returns by playing with the volatility but it comes with its own risks.
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