A specific type of trading instrument included in the derivatives category is futures and Options (F&O). In recent years, they have risen to prominence in the stock markets. A derivative in trading is a contract whose value is derived from the underlying financial asset. In F&O trading, the investor can profit from market price movements of the underlying asset without necessarily purchasing it.
These financial agreements are made to trade a securities in the future at fixed prices. This signifies that the buyer consents to buy the derivative(s) at the predetermined price at a later time. By hedging against price changes, the parties work to reduce the risk associated as a result of the contract. Profits and losses are determined by changes in market pricing, which can alter if the market conditions are not correctly predicted.
Although futures and options are both referred to as derivative contracts, they differ significantly from one another. Regardless of whether he can benefit from the trade, the buyer of a futures contract is obligated to purchase the underlying stock at the predetermined price when the contract matures.
Contrarily, in the case of options, a trader has the option to purchase or sell the stock at any point throughout the term of the contract, meaning they have the opportunity but not the responsibility to do so. There are two different forms of options: “put” options, which give traders the opportunity to sell stocks when they reach a certain price, and “call” options, which give traders the option to buy stocks at a predetermined price at any moment during the contract.
Two outcomes are possible from this. The market price of X would rise above $75 or decline below $75. A would purchase the asset if the price rose to, say, 90 since he could purchase the unit for 75 and resell it for 90 in the market. He would gain a profit of 10 when the cost of 5 is considered (90 – 75 + 5 = 10). A would, however, let the option expire if the market price of X dropped to $40 because he could get a unit for much cheaper there rather than paying an additional $35 (75 – $40) to purchase from B. However, he would lose $5 if he allowed the option to expire.
The loss is restricted to just losing the premium paid at the time the contract was signed because the buyer has the right to opt-out. Because of this, options contracts have a lower risk than futures contracts.
Despite their variances, these agreements share a common goal in that the investor wants to profit from them without covering the entire cost up front.
There are significant risks attached to both futures and options. Before trading, one should have a thorough grasp of the dangers involved and a thorough comprehension of the market and its conditions.
Follow and connect with us on Facebook, LinkedIn & Twitter.
