What is Futures and Options?

You can do Futures and Options trading in stocks, commodities and forex. There is no cash and carry in commodities and forex.

Futures and Options are called derivatives in the stock market. It is used as a trading instrument in which you are getting leverage on your capital to buy more.

Futures

In a futures contract, there is an obligation on buyers and sellers to buy the contract and the seller needs to sell and deliver the contract at a specified future date.

Let’s take an example, suppose you have bought a futures contract of Tata Steel today, the price of the contract is 520 Rs, the lot size is 1000 and the expiry date is in December.

Since it is mandatory to buy a lot of 1000 shares if you want to trade in futures, so you would need 520000 Rs to buy it. But because of these high prices, there will be no difference in delivery and derivatives if you paying the same amount of money.

Therefore brokers provide 10x or 12x times margin on your capital so that it would be easy for retail investors to trade the futures contract.

So if the bought futures contract price goes up 1 per cent today when the market closes, the profit of 1 per cent of the contract price will be credited in your demat account.

And If you lose 1 per cent in the same trading session, the amount of 1 per cent of the money will be debited from your account.

As you see, credits and debits are happening even if you have not closed your contract because of the obligations in the contract. If you sell the contract, then your account will be settled according to the ups and downs in the price.

You need to know that the expiry date in the Indian stock market is the last Thursday of the month and if the holiday comes then the day before Thursday.

There is an unlimited risk in the futures contract. You can get unlimited profit and unlimited loss.

There are maximum 3 months up to which you can buy the futures and options contract, for example, this is December but you can also buy the contracts with an expiry date up to the February month.

Options

Options contract comprises the right to buy or sell at a specific strike price. There is no obligation in this contract, therefore, there is a limited loss in this type of trading. The limit of the loss is the total capital which you have used to buy the contract in case the price goes to zero. There is unlimited profit in it.

If you are selling an options contract, then there is an unlimited risk.

There are two types of options.

1.) Call option

2.) Put option

Let’s take an example to see what is a call option. There is a Tata Steel stock, you are thinking that the stock would go up, it’s a good opportunity to make money, so you buy a call option. Call option means that you are betting that the price of the stock would go up. If it goes up then you make profits.

There is a premium you need to pay in order to buy the call option. It requires less money than buying a futures contract as premiums are low. But still, you need to buy a whole lot of that stock.

If you are bearish on Tata Steel, you think that the price of that stock is going to go down. Therefore you buy a put option.

If the stock goes down you make profits.

At the money contract

Let’s say the Nifty 50 is at 10000, so if we buy a call option or put option of a strike price of 10000, then the premium would be 100 Rs and the contract would be at the money.

In the money contract

Let’s say the Nifty 50 index is at 10000, so if we buy a call option of strike price 9900 or any other price which is lower than 10000, then it will be an in the money contract.

Similarly, if we buy put option of 10100 or any other price which is higher than 10000, it will be an in the money contract.

In the money contract have higher premiums, so if we predict any strike price which is going to touch by the stock and if we buy that contract, it will be out of the money contract but when it touches the strike price of our contract, then it goes to in the money contract and the premium increases.

Out of money

Let’s say the Nifty 50 index is at 10000, so if we buy a call option of a strike price 10100 or any other price which is higher than 10000, then it will be out of money contract.

Similarly, if we buy put option of 9900 or any other strike price which is lower than 10000, it will be out of money contract.

Time Decay

The value of the options contract decreases with time and goes to zero when it touches the expiry.

As the time runs, the premium of the strike price decays.

Premium value = Intrinsic value + Time value

Therefore keep tracking the time when you have bought an options contract.

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Saifullah Khan

Hi there, I am the owner of gloomyworld.com, read more about me here.

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