Futures and Options: An Introduction

Future and option trading, especially for beginners, is far more intricate than other types of investing, such as equities investing. This is why you should not rush into anything without first learning the ins and outs of the situation.

Firstly, you don’t need a Demat account to deal in the future and options since they are only valid till their expiry date. So you can say that they are more like contracts rather than assets. Well, there’s a lot to understand before we move ahead with investing in it, and here you will get to know it all. 

What are Futures and Options?

Futures and Options are one of the major types of stock derivatives in the entire trading market. These are like contracts that are signed by two parties to trade a stock asset at a predetermined price or maybe later. Such contracts try to evade the market risks that are involved in stock market trading and this is done by locking in the price beforehand. 

Now since the Future and Options are assets in the market, they derive their price from an underlying asset, which is known by the same name only; underlying, like shares, stock market indices, commodities, ETFs, and more. Their basics help individuals to reduce and minimalize future risks through their investments with pre-determined prices. But the thing to remember is, it can cause some substantial profits or losses if any prediction in the market is inaccurate, this is because the direction of price movements cannot be predicted or determined in any case. 

This was just an introduction to Future and Options, let’s now move ahead and understand them separately as well and know what the difference is between the two.

What is the Difference Between Futures and Options

When it comes to obligations imposed on every individual, Futures, and Options trading are very different from each other. Futures require investors to complete a contract by a pre-set date, while options give them the right to do so.

A futures contract to buy or sell an underlying security must be executed on the exact date and price. An option contract helps the buyer, but the user decides if they profit from a trade.

Well, there’s more to the difference between Future and Options but this was the most and the major of it. Let’s learn about the main Futures and Options types and who should invest in them.

What are the Types of Futures and Options?

Starting with Options, there are two types of options, call option and put option, let’s understand them in brief:

Types of Options- 

Options contracts give buyers/holders the right but not the obligation to buy or sell assets.

Here are its two types- 

• Call Option: The buyer or holder of a call option has the right, but not the obligation, to buy a certain amount of the underlying asset at that moment.
• Put Option: This is almost the same as a call option, except that the buyer or holder is not required to sell a certain amount of an asset.

Types of Future- 

Contrary to options, futures are the contracts that are to settle once they have been entered. Hence, if you enter into a futures contract, you are certainly obliged to buy or sell the underlying asset. Here are its types- 

• Financial Futures: These include futures on stocks, indices, currencies, and interest rates.
• Physical Future – This includes product future, energy future, metal future, and others.

So these were the types of future and options you have. Now, let’s figure out what Futures and Options trading is before we will talk about who should invest in it.

What is Future and Option Trading?

Futures and options are derivative instruments where traders buy or sell the underlying assets at a pre-determined price. Unlike other aspects of trading, the trader will profit from a price drop whether he buys or sells. However, the trader will have to bear a loss in the opposite price movement. 

In future trading, the trader will have to keep a certain percentage or amount of the future value as a margin with their broker to buy or sell the position, while to buy an option contract, the buyer will have to pay for the premium first.

Now that you learned about trading in Future and Options, let’s move ahead and get to know who should invest in Future and Options.

Who Should Invest in the Futures and Options?

Futures and options can make a profit, but they also carry a high level of risk. This is why futures and options trading may not be for everyone, but let’s take a look:

Hedgers- These are the traders who may get impacted because of a price movement of a certain asset and regarding this, they invest in a derivative contract to hedge off the potential risk involved with the movement of price in the asset. 

Speculators- These are the traders who invest in such securities purely to extract profits from the price fluctuation. 

Arbitrageurs- They are the ones who try to make a profit from the differences in the price of an asset because of the current market conditions.

Futures and Options With an Example

No matter how much we study the facts, it’s hard to visualize without an example. Let’s look at an example of the Future and Trading to help us get a better idea of what it means.

Futures contracts are agreements between buyers and sellers to exchange the underlying asset at a specific future date and price.

For example, XYZ’s futures contract with an expiration date of October 2 is accessible at Rs. 500 (the current value of the XYZ shares in the market is Rs. 550). The buyer has agreed to purchase the company on October 2 for Rs. 500, regardless of the organization’s current valuation.

The buyer and seller of an options contract agree to trade the underlying asset at a future price. The option buyer has the right but no obligation to buy the company on the agreed date.

I guess that certainly cleared all the remaining doubts of yours, didn’t it?