What is Futures trading?
Future trading refers to the buying or selling of financial contracts known as futures contracts. These contracts tie the buyer to purchase an underlying asset or the seller to sell an underlying asset at a future date and price.
Here are the main types of futures trading:
Stock Futures: Stock futures involve trading contracts based on individual stocks listed on the stock exchanges in India. Traders can buy or sell futures contracts representing a specified quantity of shares of a particular company. Stock futures provide an opportunity to assume the future price movements of individual stocks.
Index Futures: Index futures are futures contracts based on stock market indices such as the Nifty 50 or the Sensex. These contracts allow traders to speculate on the overall movement of the stock market rather than trading individual stocks. Index futures provide exposure to a basket of stocks representing the respective index.
Currency Futures: Currency futures involve trading contracts based on currency pairs such as USD/INR, EUR/INR, or GBP/INR. Traders can buy or sell futures contracts representing a specific amount of a particular currency against the Indian Rupee. Currency futures enable speculation on the future exchange rate between the currencies.
Commodity Futures: Generally, Commodity futures are trading contracts that are based on commodities like gold, silver, crude oil, natural gas, agricultural products, etc. The Multi Commodity Exchange of India and the National Commodity and Derivatives Exchange are major venues for commodity futures trading in India. Commodity futures provide an opportunity to speculate on the future price movements of different commodities.
Interest Rate Futures: Interest rate futures are futures contracts based on interest rates or government bonds. In India, interest rate futures are available on government bonds such as the 10-year Government of India bond (Notional 6% GOI 2034). Traders can speculate on changes in interest rates or use these contracts to hedge against interest rate risks.
What is option Trading?
Options trading involves buying and selling financial contracts known as options. Options trading is a financial tool that gives you the opportunity, but not the duty, to buy (call option) or sell (put option) an underlying asset at a predetermined price and timeframe. It offers you the power to choose whether or not to make the trade, with no binding commitments.
Here are the main types of Options trading:
Call Option:
A call option grants the holder the right, but not the obligation to do so to acquire an underlying asset at a certain price within a specified time frame.
Here are the key components of a call option:
Buyer: To acquire the right to purchase the underlying asset, the buyer of a call option pays a premium to the seller (writer) of the option.
Strike Price: The striking price is the fixed price where the buyer has the option to purchase the underlying asset.
Expiration Date: Call options have an expiration date, which is the last date on which the buyer can exercise the option.
Profit Potential: If the price of the underlying asset rises above the strike price before the expiration date, the call option can be exercised. The buyer can buy the asset at the strike price and potentially profit from the price increase. The buyer’s loss is restricted to the premium paid for the option if the price remains below the strike price or the option is not exercised before expiration.
Put Option:
The put option gives the holder the right, but not the duty, to sell a specific asset at a certain price and within a specified time period.Â
Here are the key components of a put option:
Buyer: To acquire the right to sell the underlying asset, the buyer of a put option pays a premium to the option’s seller (writer).
Strike Price: The striking price is the fixed price at which the buyer can sell the underlying asset.
Expiration Date: Put options have an expiration date, which is the last date on which the buyer can exercise the option.
Profit Potential: The put option can be exercised if the underlying asset’s price falls below the strike price before the expiration date. The buyer can sell the asset at the strike price and potentially profit from the price decline. The buyer’s loss is restricted to the premium paid for the option if the price continues above the strike price or the option is not exercised before expiration.
Difference between Futures and Options Trading :
| Â | Futures Trading | Options Trading |
| Obligation | Less flexibility. Both parties must fulfill the contract regardless of market conditions. | Both buyer and seller are obligated to fulfill the terms of the contract. |
| Flexibility | More flexibility. Buyers can choose whether to exercise the option based on market conditions. | Limited risk. The buyer’s loss is limited to the premium paid for the option. |
| Risk and Reward | Higher risk and reward potential. Unlimited profit potential and unlimited loss potential. | Premium is paid upfront for the option contract. |
| Price Determination | Prices are determined by supply and demand on organized exchanges. | Prices depend on intrinsic value (market price vs. strike price) and extrinsic value (time value and volatility premium). |
| Cost | Initial margin and daily marking-to-market. | Premium paid upfront for the option contract. |
| Underlying Assets | Commonly traded on commodities, stock indices, currencies, and interest rates. | Can be based on various underlying assets such as stocks, indices, currencies, commodities, and more. |
