It is very important for any trader to learn about Futures and options prior to entering Futures and Options trading. If you start F and O trading without any knowledge you will have no future in trading and you will be left with no option. Therefore, we have come up with a detailed blog on futures and options trading. Futures and Options come under types of derivatives markets. There are basically four types of Derivative markets i.e. Forward, Futures, Options and, Swap. In this blog, we have discussed futures and options. Read this blog thoroughly to get an understanding of futures and options trading.
This blog covers
What is futures and options trading?
How to do futures and options trading?
Futures and options trading strategies
What is futures and options trading?
Futures and options are derivatives that are being traded in a share market. These are contracts signed by two parties for buying or selling a stock asset at a predetermined price on a later date. The buyer and seller of the contract are deciding to pay the price today for some asset or security that is to be delivered in the future. In the Cash Market, any shares that you buy or sell, are traded on the same day. Futures and options refer to the trading which is done on a future date. Futures and Options come under the Derivative Markets. Anything which is derived from something else becomes its derivative. For example, Petrol and Diesel are made from Crude oil. Therefore, Petrol and Diesel are derivatives of Crude oil. Just like that, futures and options derive their price from the underlying asset.
How to do futures and options trading
In the F and O Market, shares are traded in 'Lots'. Particular companies have particular 'Lots'. A 'Lots' contains more than one share. Futures and Options are bought or sold in these 'Lots' only. You cannot buy a single share for F and O trading. Futures and Options are mainly used for Hedging, this means it is used for reducing the risks.
In order to trade in futures and options, a trader need not have a Demat account. They only need a brokerage account. A trader can trade futures and options on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). There are 100 securities and nine major indices available for F and O trading on NSE (National Securities Exchange Board of India). Futures tend to move faster than options.
Futures contracts are valid for a maximum of three months. In a typical futures and options transaction, the traders will usually pay only the difference between the agreed-upon contract price and the market price. Hence, you don't have to pay the actual price of the underlying asset.
According to the futures contract, the trade must be squared off at the specified date. Whereas, option buyers do not have an obligation to sell a contract.
No upfront margin is required to trade the futures contract. In the case of a futures contract, payment is done only when squaring off the futures contract on the specified date.
If a trader wants to buy an option on a future date then he/she needs to pay a premium only, not the full amount for that stock. If for some reason the buyer chooses not to exercise the option then the seller of the option earns his money by collecting the premium.
Futures and options trading strategies
The covered call option strategy is very popular among long-term stock investors because it can reduce the loss potential on the shares. It can create a stream of income on those shares. The strategy is very easy to execute and follow. The covered call option strategy consists of two components the first being owning at least a hundred shares of any stock and the second component is selling a call option against the shares of stock that you own. To be clear you have to have at least 100 shares of stock for every one call option that you sell for it to be a true covered call position. Selling a call option all by itself without owning any shares of stock is an incredibly risky strategy because call options increase in value as the share price continues to increase.
A Married put options strategy is also called a protective put. It is when you combine a long put option against at least a hundred shares of stock in an attempt to completely reduce or eliminate the risk of a long stock position below a certain price. A married put is a strategy that consists of buying a put option against a hundred shares of long stock. This strategy is used to cap the downside risk of a long stock position through the purchase of a put.
Bull Call Spread
The bull call spread option strategy is a strategy that profits when the stock price increases and it is one of the four vertical spread option strategies. Compared to just buying 100 shares of stock the bull call spread can make more money from a small stock price increase. This means the bull call spread offers the trader leverage. The bull call spread has less loss potential compared to buying 100 shares of stock. The return potential of a bull call spread is typically much higher than buying 100 shares of stock because when you buy 100 shares of stock the cost of purchasing those shares is going to be far more significant than buying a call spread on that same stock.
Bear Put Spread
The bear put spread option strategy is a bearish strategy that profits when the Stock price decreases but has a limited loss potential when the stock price increases. The bear put spread is one of the four vertical spread option strategies compared to shorting 100 shares of stock. The bear put spread has limited loss potential if the stock price increases. While shorting shares of the stock has unlimited loss potential since there's no limit to how much a stock's price can increase. This means there's no limit to how much the loss potential can be when shorting shares of stock. The bear put spread will also typically have a much higher return potential compared to shorting 100 shares of stock because the margin requirement for shorting a hundred shares of stock will usually be far more significant than buying a put spread.
The collar is the combination of a long stock position, a short call position, and a long Put position. The protective collar is an options strategy that consists of simultaneously buying a put option and selling a call option against a hundred shares of long stock.
The long straddle strategy profits when the stock price makes a significant movement in either direction or when implied volatility increases. Buying straddles or sometimes referred to as a long straddle is an options strategy constructed by buying a call and put option at the same strike price and in the same expiration cycle. Most of the time At The Money strike price is used. The maximum profit potential of a long straddle is theoretically unlimited because you do own a call option and there's no limit to how high a stock price can rise. The maximum loss potential for long straddle is the debit paid at the time. Most of the time a long straddle will expire with some intrinsic value but you know there are still could be a substantial loss if the stock price does not move away from that strike price. So the expiration breakeven prices are going to be the strike price plus the debit paid and the strike price minus the debit paid. So to make money on a long straddle at expiration the stock price has to have moved more than the debit you paid away from the straddle strike price.
The long strangle is an options strategy that profits from a large movement in the stock price in either direction. If the stock price moves significantly to the upside or downside the long strangle will be a good strategy. The long strangle is simply when you buy a strangle. So buying strangles is an options strategy that consists of purchasing an Out-Of-The-Money call input on a stock in the same expiration cycle. Since the long strangle is technically a neutral strategy the long strangle requires a significant movement in the stock price or implied volatility to profit. Therefore when you buy a strangle you need the stock price to move up or down significantly or you need implied volatility to increase in order to turn a profit.
Butterfly spread can be constructed with either all calls or all puts and depending on which option type you use. The calculations will be different in some cases. The long butterfly spread is a limited risk-neutral option strategy that consists of simultaneously buying a call or put spread and selling a call or put spread that shares the same short strike.
The iron Condor can be market neutral meaning that you do not have to pick a specific stock price movement in order. For your position to profit, the iron condor is a limited risk strategy meaning that you know a hundred percent of your risk before you put the trade on. When selling iron condors you can make money just from the passage of time as long as the stock price remains within a specified range of your choosing. The iron Condor can also be adjusted to reduce the loss potential.
The long iron butterfly is essentially a way to buy a straddle at a reduced cost but with that comes less profit potential as well. The long iron butterfly is the same thing as buying an iron butterfly and this strategy consists of simultaneously buying a call input at the same strike price or a straddle while also selling an Out-Of-The-Money call and Out Of The Money Put against the long options. So you are essentially buying a straddle and selling a strangle against that straddle. Another way to interpret the strategy is the combination of a long call spread and a long put spread.
Future and options are the type of derivative that derives their value from the underlying. If you have proper knowledge you can gain a fair amount of profit by trading in F and O. There are several F and O strategies available. You need to choose the one that suits your portfolio needs wisely. This way we hope by going through this blog you have gained knowledge about what is F and O trading, futures and options trading strategies, and how to do futures and options trading.