What is Futures & Options (F&O)?

The F&O meaning refers to the primary types of stock derivatives available to investors in the stock market. It is a contract between two counter parties for buying/selling a stock asset at a predetermined price on a specified date in the future. The expiry date of each contract is established prior to the trade, allowing traders to reduce the exposure to market volatility associated with holding stock positions. Each product provides investors with an opportunity to hedge against price fluctuations of underlying assets by locking in their investment costs until the expiration date of the option or future. This article explains what are futures and options trading.

Difference Between Futures and Options

The following table highlights the difference between futures and options: 

Types of Futures 

After understanding what are futures options let’s understand their types 

Index futures

Index futures are contracts whose underlying value is based on an index of stocks. 

Currency and Commodities Future 

Currency futures, also known as foreign exchange futures, allow specific quantities of currency to be purchased or sold in a specified time frame.  

Interest Futures 

Interest futures are interest rate futures contracts with an underlying asset that pays interest. The buyer and seller shall agree to provide an interest-bearing asset at a specific price in the future. 

Stock futures

These contracts allow you to buy or sell a specific stock at a specified price on a particular date. Once you purchase the product, traders are bound to observe the conditions of the contract. 

Types of Options 

There are two types of options trading:  

Call option 

In call options, traders can buy the underlying financial security at an agreed price before or on expiry. 

Put option 

The put option allows you to sell your underlying financial security on a predetermined date. 

Basic Terms to Know for Futures & Options Trading 

After understanding what is F&O in stock market , let's study some key terms: 

Underlying Security: The underlying security is crucial to F&O trading since it determines the worth of a derivative. This can include currencies, indices, commodities, equities, bonds, and interest rates. 

Strike Price: The price at which the derivatives trader or contract owner agrees to purchase or sell the derivative on a certain date. 

Premium: The current option price that the buyer now pays the seller. As the underlying assets become more volatile, premiums rise as well. 

Expiration Date: The deadline contract owners provide for traders to act regarding their rights or responsibilities. 

Who Should Invest in Futures and Options? 

The following are types of investors who can consider investing in futures and options: 

1. Speculators: Speculators trade F&O contracts to gain from price movements without owning assets. High risk and leverage make this suitable only for experienced traders with strong analysis and discipline. 
2. Arbitrageurs: Arbitrageurs profit from temporary price differences across markets by buying low and selling high simultaneously, improving market efficiency through quick execution and access to multiple platforms. 
3. Retail and Institutional Investors: Institutional investors use F&O for risk management and structured strategies, while retail investors seek short-term gains or hedging, requiring caution due to leverage and volatility risks. 
4.  Hedgers: Hedgers use futures and options to protect against adverse price movements, aiming to reduce uncertainty and stabilise exposure to volatile assets or input costs. 

Example of Options and Futures Trading 

Let’s understand what is future and option trading is with the help of example: 

Example of Futures Trading 

Let’s illustrate this with an example. 

 Suppose, on a specific date, an investor bought a futures contract to buy 100 shares of Company ABC at Rs. 50 per share. The investor will receive these shares of Rs. 50 at the end of the agreement, irrespective of the current prevailing price.  

• If the price goes up to Rs. 60, the investor will get shares of Rs. 50, which means the investor will make a nice profit of Rs. 1,000. 
•  However, the investor will still have to buy them at a value of Rs. 50 each if the stock price drops below Rs. 40. In this scenario, the investor will lose Rs. 1,000. 

 There are other assets besides equities on which futures can be traded. 

Example of Option Trading 

Let's take an example where an investor has bought a call option to purchase 100 shares of Company ABC for Rs 50 per share on a specific date. 

• However, when the expiry term ends and the share price drops to Rs 40 or below, the investor loses interest in carrying out the contract because the investor would lose money. 
• The investor can then decide not to purchase the shares at Rs 50. Therefore, the only thing the investor will lose on the deal, rather than losing Rs 1,000, will be the considerably smaller premium paid to enter the contract. 

How to Trade in Futures and Options? 

Follow the steps below to trade futures and options. 

 Step 1: You need to set up an account for buying and selling futures and options contracts to start doing business and learn how to deal with them.  

Step 2: After signing up, you can log into your account by clicking the login page. You can also access your trading account via a mobile application or the website from any computer. 

Step 3: You can research what kind of future or option you have and which will best suit your needs.  

Step 4: Enter the order details when you have chosen an option. To purchase futures and options, the strike price will be applied. The strike price for the put or call options shall be the market value at which those contracts are performed. If investors believe prices will increase or decrease, buy a call or sell a put option. 

Disclaimer: All investments are subject to market risks, economic conditions, regulatory changes, and other external factors. Returns are not guaranteed and may vary based on market performance and investment tenure. Investors should assess their risk tolerance and financial objectives, conduct their own research, and consult a qualified financial advisor before making any investment decisions. 

Conclusion 

Futures and options help investors manage trading risks and use leverage by paying margin instead of the full contract value. While these instruments allow speculation and the chance of high returns, they also involve significant loss due to market volatility. A proper understanding of F&O concepts is essential before trading. A share market app called BlinkX helps investors track prices, place trades, and manage portfolios, supporting gradual learning through smaller investments.