What is Futures and Options in Stock Market?

What is Futures And Options in Stock Market

Trading in the equity market has become one of the prominent income sources for many individuals. People trade in shares and securities to make good money regularly. If the traders are able to get their position right in the stock market, nothing can stop them from being wealthy and rich. One such segment where traders are very active in the futures and options segment. In this article, we will present a future and options tutorial where the beginners can learn how things play out in this segment. In addition, you will also learn about the difference between futures and options.

 

Firstly, let us understand the meaning of F&O

What is Future in Share Market?

Future is a contract in which the buyer is obligated to honor the contract. The contract seller shall have the obligation to buy or sell when the buyer exercises his right. Future contracts require higher margin in comparison to options. These contracts are popular among arbitrageurs and speculators. Future contacts have the potential to generate unlimited profits and unlimited losses.

What is Option in Share Market?

Option contract holder has no obligation on the buyer to hold or sell. The seller of the contract has the obligation to buy or sell when the buyer exercises his rights. In comparison to future contracts, the options contracts require a lesser margin. Generally, hedger takes a position in these contracts. Option contracts have the potential to generate unlimited profits and unlimited losses.

Difference between Futures and Options  

  • Futures are easy to understand in comparison to options.
  • Buying futures is relatively easier in comparison to options.
  • The risk in futures is high. On the other hand, the risk in options is limited to the premium paid.
  • A futures contract requires buyers and sellers to transact in shares on a specific future date. While in the case of options, the investor has the right but not the obligation to buy or sell any share at a specific date or time.
  • In future contract, the trading is simple. If you expect the price to go up, you buy a futures contract of the stock and if you expect the price to fall, you sell a futures contract of the stock. In the case of option contracts, there will be different strike price for the same stock call and put option with a different premium on them.
  • In future contract, no advance is to be paid expect a commission. In the case of options, you pay a premium which is a small percentage of the entire amount.
  • In future contracts, time value of money is not considered. On the other hand option contracts rely heavily on time value of money.

 

Let us now understand how trading in done in Futures and Options.

Trading in Futures and Options

In the stock market trading is done in 2 segments;

  • Cash segment
  • F&O segment

In the cash market, the participants can buy or sell any number of shares they want. But in the future and option segment, the participants can buy and sell contracts which have a pre-determined lot size. Like for example if one lot of Reliance Industries is of 125 shares then buying one lot of Reliance Industries in the future market is as good as buying 125 shares of the company.

 

The lot size of stocks in the future and option segment differ from each other. When you purchase shares in the cash segment you have to pay for all the shares you buy. The benefit of trading in future and options segment is as follows;

 

  • When buying the option lots you have to pay a fee known as “premium”.
  • When purchasing the future lots you pay an “initial margin” amount which is equal to the fraction of the share price.

Let us now understand the meaning of lot size.

Meaning of Lot Size

Lot size refers to the number of underlying shares that are part of a single contract. To put it another way, lot size refers to the number of shares a trader can purchase or sell in a single lot of any particular stock which is a part of the future and option segment.

What You Can Trade in Future and Options?

Apart from stocks that are part of the future and option segment, there are many more underlying securities where you can take the position. Nifty, Bank Nifty, Nifty Pharma and other indices of the nifty are available for trading in futures and options segment. The contracts in the indices expire on every Thursday of the week. While the contracts for stock expire on the last Thursday of every month. In case, and Thursday is a holiday, the contract shall expire on a trading day before Thursday. Contract expiry means that you have to close your position in the particular stock or indices. SEBI keep changing the future and options norms to attract more participants and enhance the trading volume.

 

Let us now understand how the size of the lot is determined.

Determination of Lot Size

On 10th January, the Securities and Exchange Board of India (SEBI) took the decision to standardize the lot size for different stocks depending on their price. During that time the Standing Committee on Finance, a Parliamentary Committee made an amendment to the Securities Contract (Regulation) Act, 1956 by recommending the change in minimum contract size of the derivative contracts in the Indian market to be not below Rs. 2,00,000.

How to Trade in Options and Options?

The contracts in future and options are traded for 1 month, 2 months and 3 months. For example, in the month of March 2019, you can trade in March futures, April futures and May futures of a stock. As we know, the stock contracts expire on the last Thursday of the month. Due to the time value, the future contracts trade at a premium in comparison to the spot value. Trading in futures is easy to understand in comparison to options. This is because options trade the premium which can be difficult to understand for the beginners. The same stock shall have different strike trade for call options and put options.

About Us

Nifty Trading Academy is one of the most popular stock education providers in India. We teach the beginners and old traders about taking positions in stock after reading the charts of a stock. Our in house professionals teach the traders the art of reading the technicals of a stock. By learning the technical analysis and chart reading you can become not only a successful trader but also a successful investor. All you need to do is drop us an e-mail or call us to know our quotations. You can also reach us if you need further information or have a query. We will be glad to serve you.

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