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Traders with a view on
markets and a risk appetite can take exposure to the Nifty by paying just a
fraction of the index’s value through Nifty options and futures.
1. What are Nifty futures and options?
Nifty futures are a contract that gives its
buyer or seller the right to buy or sell the Nifty 50 index at a preset price
for delivery at a future date. Nifty options are of two types —call and put
options. A call option on Nifty gives a buyer the right, but not the
obligation, to buy the index at a predetermined price during a specified time
period. Similarly, a Nifty put gives its buyer the right to sell the index. A
seller of the options is obliged to give or take delivery of Nifty from the
buyers. In practice index futures are cash settled, like their European
counterparts.
2. How does a Nifty futures and options
contract work?
Suppose trader A feels Nifty will rise from
18700, He can buy one lot (75 shares) of Nifty futures by putting a margin at a
fraction of the contract cost. His counterparty trader B sells her Nifty at
that level. If Nifty rises to, say, 18800 A has the right to buy the index at
18700 from the counterparty and sell it to him at 18800, gaining Rs 5000
(100×50). If the Nifty futures fall to 18600, B sells the futures to A for
18700 even though Nifty trades at 18600, which means the buyer faces a Rs 100 a
share loss.
As opposed
to buying a futures contract, A can buy a 18700 call option on Nifty by paying
a premium of Rs 200 (closing price on Friday) per share. If Nifty jumps by 100
points at expiry to 18800 the option value will rise by around Rs 100. The
seller of the option has to in this case fork out the money. However, the call
buyer could also have an unrealised loss if the Nifty falls by a similar
extent. Both futures and options are cash settled except where specified for
compulsory delivery by the exchanges.
3. What’s more advantageous – buying a futures or options contract?
Both have their advantages and disadvantages. An option seller has to place a
high exposure and Span margin with the exchange that’s way above the option
price or premium she receives from a buyer. However, to buy or sell a futures
contract, both buyer and seller put up the same margin, which is around 10 per
cent of the contract’s overall value. Again, holding an option for long results
in loss of value due to time decay, which does not happen in case of futures,
which also can be rolled over, unlike the former.
But, gains and losses in futures can be unlimited. In options losses (for the
buyer) are limited to the premium paid (sellers of options are exposed to
higher loss of risk, though) while profits (buyer) are very high.
