Beginners Guide to Futures and Options Trading

You've probably heard of futures and options trading in some form or another. However, the majority of individuals are unfamiliar with this subject. So, in today's blog, we'll go through what futures and options contracts are. How do they differ from one another? And what are their advantages and disadvantages over one another? So, let's get started.

 

What are futures and options contracts?

Futures and options, unlike forward contracts, are derivative contracts that are traded and regulated by the Securities and Exchange Commission (SEBI). Although futures and options contracts are sometimes used interchangeably, their meaning and execution are vastly different. Future contracts are legally binding agreements between two parties to buy or sell an asset in the future at a fixed price. Futures contracts are primarily used to hedge or speculate against the risk of price volatility in the underlying asset and are regulated by the stock exchange. Whereas "option contracts" are contracts that give the contract's buyer or seller the right but not the obligation to buy or sell a specified underlying asset at a predetermined price in the future. Investors typically use option contracts to profit from price movements in the underlying asset.

How do the future and options differ from one another?

The main distinction between futures and options contracts is that in a forward contract, both parties are responsible for carrying out the contracts as agreed, whereas, in the case of options, this is not the case. The buyer or seller of options purchases the right to buy or sell the contract at a specified price and at a specified time but has no obligation to execute the contract. If a person who has purchased the rights, either the buyer or the seller, incurs any kind of loss in executing the contract, he has the right not to execute the contract and thus create a hedge against the investment, resulting in a minimum loss equal to the premium defined when the contract was entered between the parties.

What are the pros and cons of futures and options?

Futures and options are financial derivatives whose value is determined by an underlying asset, such as a stock, commodity, or currency.

Futures contracts are agreements to buy or sell an underlying asset at a specified future price and date. They are commonly used to protect against potential losses by hedging against price movements in the underlying asset. They can also be used as a speculative tool by traders to profit from price movements. Futures trading, on the other hand, entails significant risk because the contract's value can fluctuate rapidly and requires a high level of knowledge and expertise to use effectively.

Options contracts, on the other hand, provide the holder with the right but not the obligation to buy or sell an underlying asset at a predetermined price and date. They are more adaptable than futures since they can be used to speculate on or hedge against price swings. Options provide the leverage to earn big earnings with a minimal initial investment. However, options trading, like futures, carries significant risk and requires a high level of knowledge and ability to use it efficiently. Furthermore, options have an expiration date and might lose value if not exercised or sold before that date. Options also require parties to put down an initial margin to enter into a binding contract and are relatively less flexible, making them an unappealing investment option for people with a limited appetite for risk.

Is it permissible to trade futures and options in India?

Futures and options trading is permitted in India and regulated by the Securities and Exchange Board of India (SEBI) The two primary exchanges in India where futures and options are exchanged are the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). These exchanges have rigorous rules and regulations in place to promote a fair and orderly derivatives trading sector. The SEBI, India's securities market regulator, also supervises futures and options trading to ensure that it is transparent and fair. Certain types of derivatives, such as options on single stock futures, are nevertheless prohibited in India. This is because they are deemed excessively hazardous and can generate significant market volatility. Furthermore, to prevent excessive speculation and protect the interests of investors, the SEBI has imposed derivatives trading regulations such as position limits and margin requirements.

Conclusion

Finally, both forward and option contracts are derivatives and are regulated by the Securities and Exchange Board of India (SEBI). These contracts operate on the high-risk, high-profit principle and are preferred by those with a high-risk appetite. Futures and options do not involve price gambling, but they do require study to achieve the desired results. This segment of the market is still untapped by investors, but as the number of investors grows, it has the potential to generate high employability for those involved.