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What are Futures and Options?
A Future is a right and an obligation to buy or sell an underlying stock (or other assets) at a predetermined price and deliverable at a predetermined time. Options are a right without an obligation to buy or sell equity or index. A Call Option is a right to buy while a Put Option is a right to sell.
So, how do I benefit from options and futures?
Let us look at futures first. Assume that you want to buy 2850 shares of Tata Motors at a price of Rs.500. That will entail an investment of Rs.14 lac 25 thousand. Alternatively, you can also buy 1 lot (consisting of 2850 shares) of Tata Motors. The advantage is that when you buy futures, you only pay the margin which (let us say) is around 20% of the full value. That means your profits will be five-fold that of when you are invested in equities. But, the losses could also be five-fold and that is the risk of leveraged trades.An Option is a right without an obligation. So, you can buy a Tata Motors 500 Call Option at a price of Rs. 10. Since the lot size is 2850 shares, your maximum loss will be Rs. 28500 only. On the downside, even if Tata Motors goes up to Rs .400, your loss will only be Rs. 28500. On the upside, above Rs. 510 your profits will be unlimited.
How to trade in Options and Futures?
Options and Futures are traded in contracts of 1 month, 2 months and 3 months. All F&O contracts will expire on the last Thursday of the month. Futures will trade at a Futures price which is normally at a premium to the spot price due to the time value. There will only be one Futures price for a stock for one contract. For example, in November 2021, one can trade in December Futures, January Futures and February Futures of Tata Motors. Trading in Options is slightly more complicated as you actually trade the premiums. So, there will be different strikes traded for the same stock for Call Options and for Put Options. So, in the case of Tata Motors, the Call Options premium of 500 call will be Rs. 11 while these Option prices will be progressively lower as your strikes go higher.
Understanding some Options and Futures basics
Futures offer the advantage of trading equities with a margin. But the risks are unlimited on the opposite side irrespective of whether you are long or short on the futures. When it comes to options, the buyer can limit losses to the extent of the premium paid only. Since options are non-linear, they are more amenable to complex Options and Futures strategies. When you buy are sell futures you are required to pay upfront margin and mark-to-market (MTM) margins. When you sell an option also you are required to pay initial margins and MTM margins. However, when you buy options you are only required to pay the premium margins. That is all!
Understanding the quadrants of Options and Futures
When it comes to Futures the periphery is quite simple. If you expect the stock price to go up then you buy Futures on the stock and if you expect the stock price to go down then you sell Futures on the stock or the index. Options will have 4 possibilities. Let us understand each one of them with an Options and Futures trading example. Let us assume that axisbank is currently quoting at Rs. 1000. Let us understand how different traders will use different kinds of options based on their outlook.
