Calvin In the fast-paced world of stock markets, Futures and Options (F&O) trading has become a popular choice among investors looking to hedge risks, speculate, or diversify their portfolios. Commodity trading is also a significant segment where F&O trading is utilized to manage price fluctuations of raw materials. However, F&O trading can be complex, and it’s essential to understand the intricacies before diving in. This blog will break down the basics of futures and options trading, along with its key terminologies, helping you get a clear idea of how FnO trading works.
What Are Futures and Options?
Futures and options are both types of derivatives, meaning their value is derived from an underlying asset, such as stocks, commodities, or indices. F&O trading involves contracts, not the actual asset. These contracts give investors certain rights or obligations to buy or sell the underlying asset at a predetermined price and date.
Futures
A future is a contract where two parties agree to buy or sell an underlying asset at a specified future date and price. The buyer is obligated to purchase, and the seller is obligated to sell the asset at the agreed-upon price when the contract expires. Investors use futures to hedge against price fluctuations or to speculate on the future price of an asset.
For example, if you expect the price of a particular stock to rise, you can enter into a futures derivative trade on stock exchange by buying a futures contract. If the price increases as you predicted, you can profit by selling the contract at a higher price before the expiry date.
Options
An option is a contract that gives the holder the right, but not the obligation, to buy or sell an asset at a predetermined price before or on the contract’s expiry date. But what is call and put option in future and options?.
Call Option: It gives the buyer the right to purchase the underlying asset at a predetermined price within a specific timeframe. Investors buy call options if they believe the asset’s price will rise.
Put Option: It gives the buyer the right to sell the underlying asset at a predetermined price. Investors buy put options when they expect the asset’s price to fall.
One key concept to grasp is that options come with option contract sizes, which refer to the number of underlying assets (often stocks) the contract controls.
Futures Vs Options Difference
The key difference between options and futures lies in the obligations. With a futures contract, both the buyer and the seller are obligated to fulfil the contract at expiry, whereas, with options, the buyer has the right but not the obligation to exercise the contract.
Why Do We Do Options Trading in Stocks?
Options trading is widely used because it offers flexibility and can be less risky than futures. Traders can limit their potential loss to the premium paid for the option while still benefiting from price movements in the underlying asset.
For example, an options trader may buy a call option on a stock that they expect to rise in price. If the stock performs as expected, the trader can exercise the option to buy it at a lower price and sell it at a higher market price, thus profiting from the price difference.
How F&O Trading Works?
Now that we’ve answered what is option trading, let’s explore how it works:
Decide on a Strategy
Traders usually enter F&O trades with the aim of hedging or speculating. Hedging minimises risk by locking in prices while speculating is based on anticipating price movements to earn profits.
Open Demat Account
A Demat account is mandatory for trading FnO. Several stockbrokers allow you to open free Demat account in just five minutes.
Choose a Contract
Once you have a Demat account, you can select F&O stocks or indexes for trading, such as stocks in futures India or an index like the Nifty 50.
Contract Size
Futures and options trading requires you to choose a contract size that determines the number of units (typically shares or commodities) in the contract.
Trade Futures and Options
You can then enter the F&O trade by purchasing either a future or an option contract.
Monitor the Market
During the life of the contract, you can track the performance of your FnO stocks or indices and decide whether to hold the contract until expiry, sell it early, or in the case of options, let it expire if it’s out-of-the-money.
Fundamentals of Futures and Options Market
The fundamentals of the futures and options market revolve around understanding market sentiment, timing your trades, and managing risk. Trading FnO allows investors to:
Leverage: You can control a large position with a smaller amount of capital compared to traditional stock trading.
Hedge Risks: By using call and put options, you can protect your portfolio against adverse price movements.
Speculate: Traders can take advantage of price movements in the underlying assets to earn profits, but this comes with the risk of potential losses.
Futures and Options Example for Beginners
For beginners, let’s take a simple futures and options example:
Futures
Assume you predict that Company X’s stock price will rise. You enter a future options trading contract to buy 100 shares at ₹1,000 each in two months. If the price rises to ₹1,100, you can profit by selling the contract before expiry.
Options
Let’s say you buy a call option on Company Y’s stock, which trades at ₹500. You purchase the option for ₹50, giving you the right to buy the stock at ₹520 within a month. If the stock rises to ₹600, you can buy at ₹520 and sell at ₹600, profiting from the difference.
F&O Trading with HDFC Sky
Ready to start F&O trading and unlock the full potential of futures and options? Whether you’re a seasoned trader or a beginner, you can gain access to world-class trading platforms with HDFC Sky, offering comprehensive tools to trade F&O seamlessly.
So, whether you’re looking to trade futures or explore stock trading options, our intuitive F&O app offers everything you need to master F&O trading, from educational resources to live market data. Don’t miss out on opportunities—download the HDFC Sky FnO trading app now!
