How is F&O different from equity trading?

Futures and Options (F&O), the most common types of Derivatives, differ on multiple counts from the Equity Segment. The prominent ones are their risk mitigation capacity and leverage.

As financial instruments, F&O are designed to safeguard us against wild fluctuations. But if they essentially derive their value from stocks or commodities, or currencies, how can they be different? Let's take a look. 

Risk & Reward

A combination of leverage (which refers to a possibility to enter into a sizable contract value with a relatively small amount of capital) and knowledge of risk mitigating strategies in the F&O segment can give you significantly more return on capital vis-à-vis equity trading or investing. This is despite your finest ability to time the market for highly profitable entries and exits.

The only way to bring the equity segment on par with the F&O in terms of leverage is by using the MTF – Margin Trading Facility, wherein positions can be created against the margin amount, which can be in the form of cash or shares as collateral. However, one must not get overboard on leveraged trading under MTF, as it may end up increasing your risk and reducing your reward to a great extent.

F&O trading is commonly believed to be full of risks, but on the contrary, it was invented to reduce the risk and, at times, even nullify it!

Underlying Asset Classes – Real vs. Contractual

The equity or physical delivery market obliges you to take delivery of stocks, metals, commodities, etc. But what if, as a retail trader, you wanted to trade in such market segments without bothering about taking physical stock of commodities such as gold, silver, or crude oil?

The F&O market presents such opportunities, and all that you need besides trading and a bank account is a computer system and an internet connection!

There is another perspective to it. F&O gives you the means to buy assets that can never be bought in their physical form, for example, cryptocurrency!

Sky to fly – But How?

Earning 10% profit in a single day on an investment portfolio in the equity market is not very common. But consider F&O, and it could be a humble ask!

You can apply strategies using call and put options to mitigate potential risk to your equity portfolio and also to earn additional income through option premiums. This is tantamount to earning rent on your portfolio, as stocks may not always appreciate in value and stagnate for a while.

Did you know that even being an investor, you can earn up to 24 to 36 per cent per year by selling call options consistently, month-on-month, with proper view building? Traders can use strategies such as Vertical Spreads and Ratio Spreads to minimize risks and optimize returns.

There is a common misunderstanding among equity investors that, unlike equity investments, F&O requires one to watch markets on a continuous basis.

Many F&O traders sit in front of the screen, watching markets tick by tick. This is rather counterproductive and bad for their emotional and financial health. Option strategies not only help to reduce the risks, but also give time-freedom that you die for.

India being a great growth story, both these segments are poised to prosper. Make no mistake – the F&O segment has the potential to make you rich and Equity to keep you rich!

(Author- Avadhut Sathe, Founder of Avadhut Sathe Trading Academy)