All you need to know about futures and options trading

The futures and options (F&O) are derivative instruments that derive their value from the underlying asset. They are used primarily to hedge an investment against losses. Read further to know how they work.

Vimal Joshi, MintGenie Team
Published17 Jul 2022, 09:38 AM IST
Under F&O trading, the investor doesn’t necessarily have to buy the underlying asset but can gain from its price fluctuations in the market.
Under F&O trading, the investor doesn’t necessarily have to buy the underlying asset but can gain from its price fluctuations in the market.(Unsplash)

Futures and Options (F&O) are a particular kind of trading instrument falling in the category of derivatives. They have gained prominence in stock markets in recent years. In trading, a derivative is a contract that derives its value from an underlying financial asset. Under F&O trading, the investor doesn’t necessarily have to buy the underlying asset but can gain from its price fluctuations in the market.

How do these work?

These financial contracts are signed at predetermined prices to trade a security in the future. This means that the buyer agrees to purchase derivative (s) at a future date at the decided price. As a result of the contract, the parties strive to minimize the risk involved by hedging against price variations. Meanwhile, the changes in the market price ascertain the profits or losses, which can go in either direction if the market conditions are not accurately predicted.


READ MORE: How do futures contracts rollover in India?

The difference

Although both futures & options are known as derivative contracts, there is a significant difference between them. In futures, the buyer has an obligation to buy the underlying stock at the predetermined price when the contract matures, regardless of his ability to earn profit because of the trade.

On the other hand, in the case of options — a trader has a choice to buy or sell the equity any time during the duration of the contract i.e. one has the right but not an obligation to buy or sell the security. There are two types of options: the ‘call’ option where a trader has an option to buy the stock at the predetermined price anytime during the contract and the ‘put’ option where the trader has the option to sell the stock when it reaches a specific price.

An Illustration

When the price of one unit of share X is Rs 50. Two traders A and B get into an option contract for which A pays Rs 5 to B and in which, A would have the option of buying one unit of X from B at Rs 75 after one month.

This can lead to two scenarios. The market price of X becomes higher than Rs 75 or would fall lower than Rs 75. If the price becomes higher, say, Rs 90 then A would buy the asset because he can buy the unit at Rs 75 and sell it for Rs 90 in the market. When the cost of Rs 5 is taken note of, he would make a profit of Rs 10 (90 – 75+5 = 10).

On the other hand, if the market price of X falls to Rs 40 then A would let the option lapse because he can buy a unit of X from the market for much less instead of spending an extra Rs 35 (75 - 40) to buy from B. However, when he lets the option lapse, he would lose Rs 5 that he paid to buy the option.

We explain the concept of futures and options. 

Since the buyer has an option to opt-out, the loss is limited to only losing the premium paid at the time of signing the contract. Due to this, the risk is comparatively less in options contracts than in futures.

Notwithstanding the differences, these contracts are fundamentally similar as the investor aims to profit from them without paying the full cost upfront.

Both futures and options have considerable risks associated with them. Thorough knowledge of the market and market conditions is highly valuable and one should have a deep understanding of the risks involved before trading.

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.MoreLess
First Published:17 Jul 2022, 09:38 AM IST
HomeMarketsAll you need to know about futures and options trading

Most Active Stocks

Tata Steel

157.75
03:43 PM | 19 JUL 2024
-8.6 (-5.17%)

Tata Power

414.15
03:59 PM | 19 JUL 2024
-15.85 (-3.69%)

Bharat Electronics

306.30
03:45 PM | 19 JUL 2024
-7.2 (-2.3%)

Zee Entertainment Enterprises

137.55
03:57 PM | 19 JUL 2024
-4.9 (-3.44%)
More Active Stocks

Market Snapshot

  • Top Gainers
  • Top Losers
  • 52 Week High

Tata Teleservices Maharashtra

102.11
03:59 PM | 19 JUL 2024
4.68 (4.8%)

Rail Vikas Nigam

614.00
03:59 PM | 19 JUL 2024
27.65 (4.72%)

Jubilant Pharmova

752.25
03:43 PM | 19 JUL 2024
25.3 (3.48%)

One 97 Communications

458.70
03:55 PM | 19 JUL 2024
13.65 (3.07%)
More from Top Gainers

Recommended For You

    More Recommendations

    Gold Prices

    • 24K
    • 22K
    Bangalore
    75,217.00292.00
    Chennai
    75,657.001,099.00
    Delhi
    74,485.00-659.00
    Kolkata
    74,485.00-73.00

    Fuel Price

    • Petrol
    • Diesel
    Bangalore
    102.86/L0.00
    Chennai
    100.75/L0.00
    Kolkata
    104.95/L0.00
    New Delhi
    94.72/L0.00
    OPEN IN APP
    HomeMarketsPremiumInstant LoanBudget