Futures and Options (F&O) are derivative products in the stock market that derive their values from an underlying asset, like shares or commodities. Future and Option are two derivative instruments where the traders buy or sell an underlying asset at a pre-determined price. The trader makes a profit if the price rises. In case, he has a buy position and if he has a sell position, a fall in price is beneficial for him. Futures and Options are among the key instruments of derivatives trading. Futures and Options are contracts signed by two parties for trading a stock asset at a predetermined price on a later date. Such contracts try to hedge market risks involved in stock market trading by locking in the price beforehand.
Futures and options trading is widely practised on leverage, wherein the entire cost of trading does not have to be paid upfront. Instead, a brokerage firm finances a stipulated percentage of an entire contract, provided an investor keeps a minimum amount in the investor’s trading account. Trading futures and options is widely conducted based on leverage. Here, the complete cost of trading is not paid initially upfront. Rather, a broker can finance a stipulated portion of the entire contract, provided a minimum amount is maintained by an investor in the investor’s trading account. This makes the profit margin of the investor rise significantly.
Futures and Options trading can be classified into different types. Hedgers primarily opt for physical trade wherein the asset is exchanged upon maturity of the contract. It is particularly popular in the commodity market, wherein physical trade is undertaken by producers and companies to keep the cost of raw materials at a fixed level. It ensures stability in the price levels in an economy.
Futures and Options trading involves costs such as brokerage, GST, stamp duty, statutory charges, and STT on F&O trades. These costs add up, and traders need to keep a constant eye on the costs that they are incurring in F&O. If the ratio of profits to transaction cost is not better than 3:1, then traders are justifying their effort trading in F&O.
