A Perfect Guide To Futures And Options Trading
Futures and options trading is more complex than equity investing and you need to understand the nuances better. While trading in F&O contracts, only a share trading account is required; as they are valid till their expiry date. F&O trading is an agreement between two parties for buying or selling an asset at a pre-decided price on a future date. Hence, they are more like contracts rather than assets. So, let’s first understand what is F&O trading in the share market. Futures and options trading for beginners can be a complicated experience. Start your journey of learning about futures and options with this quick beginner’s guide on how to trade in F&O.
Things You Need To Know Before Your First Future & Options Trade
- The futures market works both ways. Futures are leveraged products, so your profit can be multiplied. Just imagine you buy stocks worth Rs 100000 in futures by paying Rs 20000 margins. If the price goes up by 10 % then the profit of Rs 10000 on your margin is 50 % as it is 5 times leveraged. Likewise, if the price goes down by 10 % then the loss of Rs 10000 on your margin is 50 % as it is 5 times leveraged.
- Buying options means limited risk, but you rarely make money. Though many small F&O traders prefer to buy options because your risk is limited to the premium paid. The problem is that globally, over 97% of the options expire worthlessly. That means, if you buy options then you just stand a 4% chance of making money on options.
- Options are asymmetrical and that is the difference. If “A” buys RIL futures at Rs.920 and B sells these futures, then the trade is symmetrical for both parties. But in the case of options, the buyer’s loss is limited to the premium, but the seller’s loss is unlimited potential.
- You can leverage by buying on margin with futures. But these margins can go up sharply in times of volatility. Assume that you bought GMR futures by paying a margin of 15%. You are prepared with liquidity up to 25%. But volatility in the stock suddenly goes up and the margins are revised to 40%. Now you are in a quandary! You either need to bring in fresh margins or your broker will compulsorily cut your positions. Be aware of this risk when you trade in F&O.
- Stop loss and profit targets are key to trading success. No matter how much you know about financial markets, if you do not define your trade-off for each trade, you will be doomed. When you trade in Futures and Options (F&O), don’t try to second guess your stop-loss levels or profit booking price. Adhere to them religiously irrespective of your view on the stock.
- If you think that brokerage and other costs on F&O are lower, then think again. In percentage terms, they may be lower than on equity, but you churn more frequently in the case of F&O. These costs add up. You pay brokerage, GST, stamp duty, statutory charges, and STT on F&O trades. If you sit down and add these up, you first need to get a perspective. Ensure that your ratio of profits to transaction cost is better than 3:1; otherwise, you are justifying your effort trading in F&O.
- Options can be used to profit in volatile markets and in lackluster markets They can also be used to trade markets where you are not sure of the direction. Options on the futures market are different than options on the exchange-traded equity markets. Option expiry days bring volatility and opportunity, whereas equities do not have option expiry days. Options on futures offer more flexibility as compared to options on equities like Nifty and Bank Nifty because an option has a finite shelf life. Equities at best have one-year options.
Futures and options trading is nothing like the rocket science that is normally made out to be. This e-book will explain how it works and how you can make better use of these innovative financial products!