The derivative segment is the most significant contributor to daily trading turnover in the Indian stock market. Futures and options (F&O) are types of derivative instruments. They are termed derivatives because their value is derived from an underlying asset, such as stocks or commodities.
In a derivatives contract, two parties agree to buy or sell the underlying asset at a predetermined price on a specific date. In the stock market context, this predetermined date is called the exit date. The objective of such contracts is to mitigate market risks by locking in the price of an asset for a future date.
A futures contract is a deal to buy or sell a stock or asset at a fixed price on a particular date. On the other hand, an options contract provides the owner with the right, but not the obligation, to buy or sell assets at a set price on a given date, known as the expiry date. This blog will explore how to trade in futures and options.
Futures and Options: Understanding the Differences
Traders frequently use futures and options, financial instruments designed to earn profits or safeguard against price changes in commodities and similar investments.
A future is a contract to purchase or sell an underlying asset, such as a stock or commodity, at an agreed price on a specific date outlined in the agreement.
Conversely, options trading enables individuals to predict changes in the value of the underlying instrument, like stocks, without owning them. Although it carries substantial risks, high potential returns and lower margin requirements have significantly boosted the popularity of options trading in India. Traders usually adopt this method to profit from fluctuations in a particular stock or index price.
How to Trade in F&O?
Futures and options trading can allow traders to earn significant profits, even though risks may be involved. You can follow some simple guidelines to get started. Here’s a detailed guide to trading in futures and options.
Open an Account
To begin trading, choose a demat account app like HDFC SKY that has advanced F&O trading. Visit the broker’s website or app, and once your demat account is set up, log in to explore different F&O options.
Select a Suitable Contract
After choosing a broker, select a futures or options contract that aligns with your investment goals and strategy. Consider factors like asset class, expiry date, and market trends before deciding.
Understand Margin Requirements
Familiarise yourself with margin requirements. Futures and options trading often require a margin deposit, which serves as collateral and helps cover potential losses. Know your broker’s margin rules and be prepared for margin calls.
Choose a Call or Put Option
You can buy futures or options at the strike price. A call option allows you to buy the underlying asset at the strike price, while a put option allows you to sell it. If you expect prices to rise, buy a call option; if you believe prices may fall, sell a put option.
Monitor Spot Prices
The spot price, reflecting the current market value of assets, plays a crucial role in pricing a futures contract. It helps you decide whether to buy or sell immediately and is a reference point for calculating futures contract costs.
Risk Management
Set up stop-loss orders or define your risk tolerance to manage potential losses. Futures and options can be volatile, so a risk management strategy is vital to protecting your investments.
Track Expiration Dates
Keep a close eye on your contracts’ expiration dates. As the expiry date approaches, the value of futures and options can fluctuate significantly, so understanding the timing is essential for making informed decisions.
Conduct Thorough Research
Research the underlying asset, considering market trends, news, and economic indicators. This helps you stay informed and anticipate market movements to make better trading choices.
Monitor Your Positions
Regularly track your open positions, including profit and loss status, to ensure you are not exposed to unexpected risks. Use your broker’s platform to stay updated on the price movements of your contracts.
Factor in Costs
Remember that F&O trading involves transaction costs, including brokerage fees and taxes. To maintain profitability, factor these costs into your trading strategy.
Things to Keep in Mind
Here are a few things to remember if you want to trade F&O, as they differ from the spot market. Understanding how to trade in futures and options better means knowing these key points before you begin:
Make a Trade Plan
Carefully plan your trades before entering a position. This involves setting a profit target and a strategy to exit if things are unexpected. The goal is to reduce the chances of making critical decisions when your money is already at stake. Fear and greed can cause you to hold on to a losing position too long or exit a profitable one too early. You do not want these emotions driving your choices.
Liquidity Matters
Traders unfamiliar with futures and options should recognise the importance of liquidity. Ensure you avoid common mistakes by ensuring your trading derivatives have enough liquidity for a smooth exit.
Out of Money
Before engaging in options trading, you should understand this crucial point. “Out of the money” (OTM) options may be cheaper, but they are often hard to cash quickly. A low-cost option can not always be your best bet. Finding a balance between cost, profitability, and liquidity is key.
Use F&O Selling for Protection
You are taking on certain risks when you do futures and options trading. This is why new traders can consider combining a regular trade with a futures or options position. This can allow the F&O trade to serve as a safeguard for the regular trade. This way, you can reduce risk and gain more insight into the derivatives market.
Conclusion
Investors aiming to grow and diversify their wealth should understand how to trade in futures and options. However, knowing when your F&O contract expires and how this can impact your investments if you want them to perform well is crucial. Since the expiration date of F&O contracts can influence stock prices, it can also affect your equity holdings.
You should monitor the underlying assets and expiry dates of every F&O contract you are considering. By staying informed, you can minimise risks, seize opportunities, and maintain control of your financial strategy. Additionally, having a clear exit strategy and staying disciplined in your approach is essential, as the volatile nature of F&O trading can lead to both high rewards and significant losses.
By managing your positions wisely and monitoring key market indicators, you can maximise the potential of your F&O trades while safeguarding your overall portfolio. With the proper knowledge, strategy, and risk management, trading in futures and options can be an effective tool for growing and protecting your investments.
You can Open Demat account and trade futures and options with HDFC SKY. Begin today and take a step towards building a brighter financial future.