What is future and option trade

The ‘future and option’ is the hottest & most widely talk subject in stock trading. Investors have many misconceptions about it. Investors think that with little effort, they can earn huge profits from ‘F & O’. Future and Option is also called ‘F & O’. At times, it can be very risky to trade in ‘F & O’. Investors should understand the pros and cons of it before trading through ‘F & O’. Experienced Investors should only try F & O with proper study and risk management. Investors should spend some decent time in the market before trying ‘F & O’ trading.

**Basic of future and option trading : what is call and put in f&o**

In this blog, we will try to understand the basic concepts and terms related to the Future and Options. We are not giving any recommendations in this blog. Our main purpose is to educate investors regarding the risks and rewards involved in ‘F & O’.

Introduction:- To understand the ‘Future and Option’, first, we have to understand, What are derivatives?.

In simple words, Derivatives are financial contracts whose value is determined by the value of underlying Assets. Assets like stocks, Bonds, currencies, commodities, etc. The future value of underlying assets fluctuates as per market conditions.

Types of Derivatives.

1… Forward

2… Future

3…Option

4…Swapping

Forward and Swapping derivatives are not traded in the stock market. In the Share Market most
commonly used derivatives are Future and Option.

For understanding the F& O trading, we should understand,

What are forward Derivatives?. Forward derivatives are non-standard contracts between
two parties to buy and sell Assets at specific price and time as agreed in contract. One of the major limitations of the Forward contract is that there is no regulatory third-party involvement in the Forward Contract.

To overcome this limitation, there comes a Future Derivatives.

Future:- Future contacts are authorized and monitored by the stock exchange. Stock Exchange takes the guarantee to purchase and sell Asset at agreed price as per the contract.

Future Contracts are of 3 types.

This Month
Next Month
Far Month

In the Future, you must take the delivery of stock at the time of the expiry period. The expiry Period can be for this month, Next Month, or Far month as per the contract. You don’t have the option to refuse delivery. You can also trade this future contract in the stock market like regular shares. Many traders trade
on Future. The future value of derivatives keeps on changing as per the market situation.

Options:-

In Options contract, you have options to buy or sell the Assets at a specific price at a specific time. You don’t have obligations like future to take the delivery at the time expiry of the contract. If the deal is in favor, the Trader will make a deal. Traders will refuse the deal if it is not in their favour. In that case, the trader will lose Margin Money or leverage.

Leverage or Margin Amount:- In option trading, traders don’t have to pay the complete amount of the contract. He has to pay Leverage or margin money. This differs from stock to stock.

Lot size:- Future and Options are traded in lot size. You can trade in a lot of 1 or 2 shares in F & O. Lot size differs from company to company. Generally lot size is 50, 100, or 200.

Point to note:- Future and option is available only for limited companies. Approximate 200 companies.

We will try to under the Options Trade by taking one example of TCS share.

Suppose we are trading options on TCS shares.

TCS’s share price is Rs. 1,000/-. A trader is expecting that this share will become 1,200=00 within a
month. So he buys the option for Rs. 1200/- at Margin money ( Leverage) is Rs. 1,00/-.

Profit in Option Trade This month TCS share value becomes 1,500=00 at the end of the option period. So the trader will pay Rs. 100/- + Rs. 1100/-. to purchase a share. At the value of Rs. 1,200/-, Traded will get a share worth Rs. 1500=00. Thus Trader makes a profit of Rs.
300=00 on 1 share.

Loss in Option Trade. Suppose the price of TCS shares becomes Rs. 9,00/- at the end of the month.

The trader has already paid a margin money of Rs. 100/-. The trader has to pay Rs. 1100/- to get this share. So if he makes the deal then he will be at a loss of Rs.300/-.

Rs. 100/- + Rs. 1100/- minus (-) Rs. 9,00/- = Rs. 300/- (Loss)

Since Trader is in the option contract, Trader has the option to cancel the deal. In that case, his loss
will be of Margin money only of Rs. 100=00.

Options are of two types.

Call Option (CE).. Call option is to buy shares.
Put Option (PE)… Put Option is to sell shares.

How the Option Trading is Risky.

Traders love to trade in Options because of leverage ( i.e. Margin). Traders don’t have to pay money for a complete lot in the Future and Options contract. He has to pay only margin money which is approx. 10 to 20 % only. Traders are tempted to take more risk.

We will try to understand the risk involved in the option by taking the same example of TCS share.

We will consider the following assumptions.

1.Suppose TCS has option lot size of 100.

2.The present value of
TCS share is 1000/-.

3. Leverage or
margin value is 100/-. per share

For purchasing 1 lot size for option trade. The investor has to pay

Margin Amount (Rs. 100/- ) x Lot Size ( i.e. 100 ) = 10,000=00

By paying Rs. 10,000=00, the Trader can purchase a Lot size of 100 shares of Price 1,000/-.

The actual value of this Lot is Rs. 1,00,000=00.

By making a payment of Rs. 10,000/-, Trader has actually purchased a share worth Rs. 1,00,000/-. This
makes Option trade very attractive.

Profit in option –

Suppose the Investor books an Option trade for Rs. 1200/- for months contract. At the end of the month price of TCS becomes 1,500/-. We will calculate how much profit Trader makes in this deal.

Trader has spent Rs. 10,000/- for 100 shares of TCS @ Rs. 1000/- per share. The actual value of the share lot is Rs. 1,00,000/-.

At the present value of the Lot will be Rs. 1,500/- X 100 Shares = 1,50,000=00.

Rs. 10,000/- Trader has already paid. He will pay more Rs. 1,10,000/- more.

Total money paid is Rs. 1,20,000/- to get shares of Rs. 1,50,000/-

Traders Profit — Rs. 1,50,000/- minus (-) Rs. 1,20,000/-

Profit – Rs. 30,000/- for Traders

From an investment of Rs. 10,000/-. Trader has earned Rs. 30,000/- profit.

Loss in Option. But suppose the reverse
happens and the share of TCS becomes Rs. 800/- at the end of the month. The trader will spend money Rs. 1,20,000=00. In return, he will get a lot of 100 shares worth Rs. 80,000/- Net loss will be Rs. 40,000/- if he makes the deal. If Trader is in future contracts, he has no option but to take delivery. The trader will have to bear a loss of Rs. 40,000/-. If he is in an Option trade, he has the option to cancel the contract. In that case, his loss will be Rs.
10,000/- i.e. margin money.

Conclusion:-

Future and options is a high-risk and high-gain type of trading.
Investors should understand the pros and cons of F & O before investing.
This type of trading is for experienced Traders and not for newbies.
The basic concept of stock trading is a must.
Investors should study Fundamental and Technical Analysis thoroughly before investing.

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