Futures & Options are the trading tools for short term trading in the financial markets.They constitute the Derivatives segment of the markets.Derivative is something which has been derived from an underlying.In case of Futures & Options,the underlying is the stock or currency or any other security.These underlying securities trade in Cash segment in the markets.Derivatives are unique as they allow the trader to play the market both ways ; up or down,unlike Cash Market where you can only buy in anticipation of selling that security on higher price.In Derivatives,you can sell the market or stock on a higher price if you are expecting a decline in the stock and buy later at lower price when stock has fallen.The difference between the selling and buying price is the profit.
Future :- A Future is a contract which gives the buyer or seller of that Future Contract a right to buy or sell the underlying security at a specific time and price.A single Contract remains valid for a month and it usually expires on the fourth Thursday of each month.So a Futures trader have to close his buy or sell position on or before the expiry day.
Option :- An Option is also a Contract which gives the buyer or seller of Option a right to buy or sell the underlying security at a later time.If the Option price rises than the buying price,trader may close his/her position and take the profit.If the desired prices are not achieved till the expiry period,the Option may be left to expire and after expiry its value becomes 0.The trader,thus,looses the premium paid to buy the Option.Hence in case of Option Contract,it is not the obligation of the trader to close this position and the position may be left to expire.
Advantages of Futures & Options :-
Futures & Options offers versatile options for the traders with short term view,say, a month or two.As we discussed above,by Derivatives it is possible to trade the markets both ways.Besides,they also provide much needed cash leverage for trading position.Lets have a look at the advantages of F&O :-
1. Portfolio Hedging : – An investor holding big portfolio of stock may not want to sell his/her all portfolio even if he/she is expecting significant fall in the markets.But it is also important to protect the portfolio from downside risk.Here Derivatives come into play as hedging tools.The risk can be managed by taking short position in the portfolio stock by taking short position either by selling Futures or buying Put Options.So loss due to downside in the stock price is neutralized by gains in short position in Derivatives.
2. Trading Tool :- Derivatives are used by speculators as trading tools who have very short time view.Moreover,they can be used for trading declines in the markets or any specific stock.
3. Cash Leverage :- Derivatives are tradable in Lots which have monthly contracts.A Lot is a fixed number of stocks of any one company.We can trade in Derivatives by investing only 15-20 % amount of the total cash value of that Lot.For Options,the margin is even less which is called as a Premium.Leverage ensures that you can earn much higher return on the money you invested than you have otherwise earned by trading in cash.But you should remember that losses are also much higher in Derivatives trading.
Risks associated with Futures & Options :
Futures and Options involve cash leverage which is actually a double edged sword.Cash leverage although ensures higher returns but losses are also equally substantial.Futures trading can be highly devastating for financial health of a trader if not done with proper research and following a strict discipline.Options,comparatively, are much safer where you can not lose more than the premium you have paid to buy an Option.
Futures & Options add much needed versatility to the trading arsenal of a trader which can be highly paying in terms of returns,the need is to trade them wisely and with necessary research and discipline.
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