F&O or futures and options are stock derivatives trading in the share market. They derive their value from an underlying asset. F&O trading involves signing contracts by two parties for stock trading at a specific price on a future date. Read on to learn the nuances of F&O trade and how you can benefit from them.
What are Futures and Options?
Future and options are contracts through which you can reduce the future risk of your investment through pre-determined prices. Through future options trading, you can speculate on the price movement of an underlying asset without actually owning it. F&O trading involves two components – futures and options.
What are Futures?
Futures are derivative contracts through which you agree to buy or sell a specific quantity of a particular asset at a predetermined price at a future date. Let us understand it with an example. Suppose you have purchased a futures contract to purchase 100 shares of a company at ₹ 50 each at a certain date in the future, irrespective of its then price.
Suppose, on the contract’s expiry date, the price of shares goes up to ₹ 60. However, because of your contract you can buy them at ₹ 50, thus earning a profit of ₹ 1000. However, if the price falls to ₹ 40, you will incur a loss of ₹ 1000. Futures contracts are available for stocks, agriculture commodities, petroleum, currency and gold, among others.
Future contracts are of two types, namely:
- Financial Futures
Financial futures refer to contracts through which you agree to buy or sell financial assets at a specific price in the future. These financial assets can include stock, bonds, or currencies.
- Physical Futures
Physical futures involve contracts through which you agree to buy or sell physical commodities at a specific price in the future date. The commodities could be wheat, oil, rice, etc.
What are Options?
Options in F&O trading are another kind of derivative contract through which the buyer or seller has the right to purchase or sell a particular asset at a certain price on a predetermined date. However, unlike futures, there is no obligation for either (buyer or seller) to buy or sell the asset. There are two types of options – call and put.
A call option gives the buyer the right to purchase a specific asset at a particular price in the future. For example, suppose you have purchased a call option to buy 100 shares of a particular company at ₹ 50 each in the future. However, the price of shares comes down to ₹ 40 at the end of the expiry period. You let the contract lapse since there is no obligation, as exercising it would mean incurring losses of ₹ 1000.
Let us now understand the put option. In the put option, you get the right to sell an asset at a predetermined price in the future. For example, if you have a put option to sell shares of a particular company at ₹ 50 each in the future and the price of shares rises to ₹ 60 before the contract’s expiry. As a put call options trader, you can choose not to sell the shares at ₹ 50. By doing so, you avoid making losses of ₹ 1000.
Futures vs Options Differences
Though futures and options belong to the derivative trading segment, they have significant differences. The table captures the differences between futures and options on various parameters:
| Parameters | Futures | Options |
| Obligation | Both parties, buyer and seller, must fulfill and execute the contract on the date of expiration | There is no obligation either for the buyer or seller to execute the contract |
| Risk involved | Futures involve high risk as both parties must fulfill the contract’s terms and conditions. This is of the prevailing market conditions | The risk is limited for buyers. However, risk is unlimited for sellers if the buyer chooses to exercise the contract. |
| Upfront cost involved | No upfront costs involved, barring margin requirements | Buyers need to provide a premium to the seller |
| Expiration | Both parties need to execute the contract at the expiration date | You can exercise the contract anytime before or on the expiration date |
Who Should Invest in Futures Options Trading?
After the Demat account opening online, the following people get involved in futures and options trading:
- Hedgers: These are investors who hedge risks and fix prices through which they can buy or sell an asset to safeguard the acquiring cost from market volatility.
- Speculators: These are investors who try to benefit from F&O trading by speculating on future price movement of a particular asset. Speculators undertake higher risks than hedgers.
- Arbitrageurs: These investors seek to profit by taking advantage of the price differences in the F&O markets.
F&O Tax
If you want to get into F&O trading, you must include the F&O trading information in your tax returns. If you fail to do so, you can get a notice from the tax department. Futures & options trading in income tax and the subsequent profit and losses must be filed using ITR 3.
Essential Things to Note About F&O trading
Before getting into the world of F&O trading, you need to take care of the following things:
- F&O trading is complex and risky. Hence, you must venture into it only after thoroughly understanding markets and their dynamics. While it offers a high potential for profit, you can also incur significant losses if you fail to execute it with utmost care.
- Ensure proper risk management with F&O. You can use stop loss to minimise losses. Equally important is not getting carried away and continuing trading after heavy losses. If you have suffered losses, take a step back and understand the real reason for the losses incurred. Proceed after you have learnt from your mistakes.
- There are several costs involved in F&O trading. This involves GST, securities transaction tax (STT) and many more. Make sure to be aware of them as these can significantly reduce your profits.
In Conclusion
If you are new to stock markets, it is advisable to venture into the F&O territory with utmost caution. Make sure to grasp the fundamentals well and start with a small amount to test the waters before investing. Among the several F&O trading app, HDFC SKY stands out from the crowd with its intuitive interface, offering a seamless trading experience.
Through this F&O app, you can get involved in F&O trading and also invest in mutual funds, stocks, and initial public offerings (IPOs) to build a diversified portfolio for yourself. Happy investing!
