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A stock, index, bond,
or commodity may be the underlying, from which futures and options receive
their value. Let's concentrate more on stock and index futures and options for
the time being. The value of a stock future or option is derived from a stock
like Tata Steel or RIL. An underlying index like the Nifty or the Bank Nifty is
what gives an index future or option its value. The previous few years have
seen a significant increase in F&O volumes in India, which now make nearly
90% of the market.
1. Use F&O more as hedge
than as a trade
This is the fundamental tenet of futures and option trading.
The fact that F&O is a margin industry is one of the factors that attracts
individual investors to it. For instance, you can purchase Nifty for Rs. 10
lakhs by making a just Rs. 3 lakhs in margin payments. You can triple your
capital's leverage thanks to that. However, that is a slightly risky course of
action to take because in futures, just as gains can multiply, losses can
likewise. Additionally, if the price movement goes against you, you must have
enough cash on hand to pay mark to market margins.
The solution is to
consider futures and options as a hedge more. Let's explore this further. If
you own Reliance and purchased it at Rs. 1100 but the CMP is Rs. 1300, you can
sell the futures for Rs. 1305 and lock in profits of Rs. 205 (futures typically
quote at a premium to spot). Any direction the price goes from here, your
profit of Rs. 205 is guaranteed. Similar to this, if you own SBI at Rs. 350 and
are concerned about a downside risk, you can hedge by purchasing a Rs. 2 put
option with a strike price of Rs. 340. You are currently insured up to Rs. 338.
You will earn from the put option and lower the
cost of maintaining the stock if the price of SBI drops to Rs. 320. By having
the appropriate philosophy, you can make F&O work efficiently.
2. Get the trade structure right; strike, premium, expiry, risk
Poor
trade structuring is another factor contributing to traders' failure to execute
F&O trades correctly. What does "structure of a F&O trade"
mean?
• Check for dividends and
see whether the cost of carry is beneficial before buying or selling futures.
• The expiry has a significant impact on futures and option trading. Both
near-month and far-month expirations are available. Although long-term
contracts might lower your costs, they are illiquid, and exiting them can be
challenging.
• Which choice for a strike
should you choose? Despite their cheap appearance, deep OTM (out of the money)
options are typically useless. Deep ITM (in the money) options are worthless,
just like futures.
• Master the art of valuing
options. According to the Black and Scholes model, your trading terminal has an
interface to determine if the option is overvalued or undervalued. Make careful
to buy options at a discount and sell options at a premium.
3. Focus on trade management; stop loss, profit targets
The last thing to focus on is how you manage the trade; more so
when you are trading in F&O. Here is why!
1. Maintaining
a stop loss for all F&O trades is the first step. Keep in mind that this is
a leveraged enterprise, thus stop loss is essential. The stop loss should
ideally be included in the trade from the beginning rather than being added
later. Online trading is above all a disciplined industry.
2. In F&O, you just book profits; everything else is merely book profits. In
the F&O trading industry, you can profit if you actively churn your
capital. Try to do this quickly.
3. Track the greatest amount of money you're willing to lose and adjust your plan
accordingly. Never wager more money than you can lose. Above all, avoid markets
when they are too complex for you to understand.
