In the dynamic world of financial markets, futures and options are key tools in the derivatives category. They serve two primary purposes: managing the risks from price fluctuations and enabling speculation on future market trends. Futures contracts are fixed agreements to buy or sell assets at a later date, securing today's prices to guard against future changes. More adaptable options allow the holder to decide whether to make similar transactions, depending on their predictions of market movements.
These tools are essential for investors looking to safeguard or capitalise on investments in an unpredictable market. At NIWS, stock market institute in Delhi, we provide in-depth training and resources to help you master these instruments and enhance your trading skills and market understanding.
Let our experts from NIWS guide you through the details of futures and options, allowing readers to gain deeper insights into the stock market's most used terms.
Futures contracts are legally binding agreements that obligate the parties to buy or sell an asset at a predetermined future date and price. Futures exchanges standardise them, specifying the asset's quantity, quality, and delivery time.
Ø Standardisation: Each contract is standardised for quantity and quality as the exchange specifies.
Ø Margin Requirements: Participants must post a margin, a fraction of the total contract value, as a financial guarantee.
Ø Mark-to-Market: Daily adjustments of the contract's market value are made, reflecting gains and losses.
Ø Hedging and Speculation: Hedgers use futures to stabilise pricing and mitigate risk from price volatility, while speculators use these contracts to profit from anticipated price movements.
| Types of Futures | Description | Common Examples |
|---|---|---|
| Commodity futures | Involve physical goods, which hedge against price changes in commodities. | Oil, wheat, corn |
| Financial futures | Financial Variables and Instruments | Interest Rates, Government-Bonds, Stock Indices |
| Currency Futures | Contracts to exchange one currency for another at a predetermined future date and price. | US Dollar/Euro. Great Britain Pound/INR, INR/USD |
| Stock and Index Futures | Futures on Individual stocks or Indices, allowing speculation on the future value of the assets. | S&P 500, Sensex, NIFTY 50, Bank NIFTY |
Options are financial derivatives that offer the buyer the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a predetermined price before a specified expiration date. This characteristic distinguishes options from futures, which involve obligations to transact.
Options are used for various strategies, including hedging (to limit risk), speculation (to capitalise on expected price movements), and income generation (through the sale of options premiums). They are complex instruments that require a good understanding of market conditions and the specific terms of the options contract.
1. Call Options: These grant holders the right to purchase an asset at a set strike price within a specific timeframe. They are typically purchased when investors anticipate the asset's price will increase.
2. Put Options: Give the holder the right to sell an asset at a designated strike price before the option expires. Put options are often bought as insurance against a decline in the asset's price.
· Pricing: The cost of an option is known as the premium, which is influenced by several factors, including the underlying asset's price, the strike price, the expiration date, and the market volatility. The premium is the price paid by the buyer to the seller of the option.
Example- If you own a call option for stock XYZ with a strike price of ₹50, and the market price rises to ₹60, you can exercise your option to buy at ₹50, potentially selling immediately at the market price of ₹60 for a ₹10 per share gain.
· Exercising Options: The option choice depends on the relationship between the asset's market price and the strike price. For call options, exercising the option yields a profit if the market price exceeds the strike price. For put options, the opposite holds.
Example- If you own a call option for stock XYZ with a strike price of ₹50, and the market price rises to ₹60, you can exercise your option to buy at ₹50, potentially selling immediately at the market price of ₹60 for a ₹10 per share gain.
Trading futures and options occur on various exchanges, including stock and commodity exchanges.
· Hedging: Minimising risk from price changes and focusing on stability by locking in prices.
· Speculation: Profiting from bets on market movements by Seeking profits through market volatility.
· Arbitrage: Exploiting market inefficiencies for profit and Aiming to profit from price discrepancies across markets
ü Market Volatility: Futures and options are highly sensitive to market changes. Sudden volatility can lead to substantial losses, especially for those without adequate risk management strategies.
ü Leverage Risks: These derivatives often involve leverage, which can amplify gains and losses, making it crucial to understand leverage dynamics fully.
ü Complexity of Products: The nature of these products requires a deep understanding of terms, market conditions, and the specific mechanics of derivatives trading.
ü Regulatory and Legal Risks: Compliance with trading regulations is essential, as failure to adhere can result in legal consequences and financial penalties.
ü Comparison of Risks: Generally, options offer a degree of risk limitation since the maximum loss is the premium paid. Futures, conversely, can result in unlimited losses, highlighting the importance of thorough market analysis and risk assessment before engaging in trading activities.
Futures and options are integral to modern financial strategies, offering sophisticated tools for risk management and speculative opportunities. Their effective use can safeguard investments and enhance profit potential under various market conditions. As you embark on trading futures and options, consider engaging with educational resources and professional advice to navigate these complex markets confidently.
NIWS offers a range of courses and support to help clarify these instruments and empower your trading decisions. Embracing these tools can significantly contribute to a well-rounded investment approach. Contact NIWS, Delhi, for more details and information.
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