How to Trade in Futures and Options - Beginners Guide

Futures and options are known as derivative products, which mean that they derive their value from an underlying commodity or asset. However, futures and options differ in fundamental ways from each other.Before you open a demat account or look for the best online trading account, ensure that you are familiar with the basics of futures and options trading. Here’s a practical guide to help you get started.

Difference between Options and Futures

Aspect	Options	Futures
Definition	This gives the buyer the right, but not the obligation, to buy or sell an asset at a specific price before a specified date.	A contractual obligation for both the buyer and seller to transact the underlying asset at a predetermined price and date.
Obligation	Buyers are not obligated to exercise the contract; they have a choice.	Both parties are obligated to fulfil the contract.
Risk	Limited to the premium paid for the option.	Unlimited potential losses for both buyers and sellers, depending on market movements.
Premium Payment	Buyers pay a premium upfront to acquire the option.	No premium is required; only a margin is maintained with the broker.
Expiry	It can expire worthless if not exercised.	Automatically executed upon expiration.
Type of Contracts	Call Options (right to buy) and Put Options (right to sell) are two types.	Single type obligates both parties to transact.
Leverage	Offers leverage as buyers pay only the premium, not the full asset value.	Provides leverage as only a margin is required instead of the full contract value.
Liquidity	Generally lower liquidity compared to futures.	Higher liquidity due to standardisation and widespread use.
Purpose	Commonly used for hedging or speculative purposes with limited risk.	Widely used for hedging, speculation, and arbitrage with higher risk.
Settlement	Can be settled by exercising the option or letting it expire.	Must be settled either through cash or physical delivery of the underlying asset.

How to Trade in Options and Futures

Trading in Options and Futures allows investors and traders to profit from market fluctuations or hedge against risks. While the derivatives share similarities, trading mechanisms are different. Find out the steps to follow for a successful trade.

Step 1: Open a Trading Account

The first step is to choose a broker that offers derivatives trading. Complete the Know Your Customer (KYC) process and activate your account for trading options and futures.

Step 2: Understand Market Trends

Understand the market conditions through a combination of technical and fundamental analysis. Study underlying asset price movements and analyse volatility to make proper decisions.

Step 3: Select the Right Instrument

Decide which type of contract suits your trading goals. For options, you’ll need to choose between Call Options, which provide buying rights, or Put Options, which give selling rights. For futures, identify the asset and contract size that align with your strategy.

Step 4: Decide on a Strategy

Develop a trading strategy based on your market expectations. Options traders often use Covered Calls, Straddles, or Spreads to maximise returns. Futures traders can take a long position if they anticipate prices to rise or a short position if they expect a decline.

Step 5: Monitor Margins and Premiums

You will need a margin account for potential loss coverage for the futures. However, options trading means a premium must be paid at the outset to purchase the contract.

Step 6: Enter the Trade

Open your trade order through your trading platform with information on contract type, expiration date, strike price, and quantity. Cross-checking will help ensure your order corresponds to your plan.

Step 7: Monitor and Control Your Position

Monitor market action and your contract’s performance. For options, decide whether to exercise, sell, or allow the contract to expire based on its value. For futures, close your position before expiration or prepare for settlement.

Step 8: Assess Risks

Implement risk management techniques such as stop-loss orders to prevent large losses. Understand the leverage in derivatives trading to avoid exposing yourself to avoidable risks.

Step 9: Review and Learn

Review your trades after each one has ended to determine what worked and what did not. Stay updated on market trends and current news to enhance your strategies.

What is Expiry in a Futures Contract?

Expiry in a Futures Contract is the date when the contract is said to expire, and the trading for that particular contract comes to an end. On the expiry date, the futures contract is settled in cash or through the delivery of the underlying asset, as stipulated in the contract terms. The traders must close their positions or fulfil their contractual obligations by this date.

Expiry is an essential factor in futures trading. It indicates the final settlement value of a contract, which affects both traders and investors. Effective risk management and trading strategies require knowledge about expiry dates.

Takeaways from the F&O Trading Process

Trading in F&O offers diversification but requires a clear understanding of its complexities. The major lesson is that research and preparation are essential. Successful trading in F&O starts with analysing market trends, understanding prices, and selecting the appropriate instrument for your financial goals.

Another key takeaway is risk management. The leverage in F&O trading multiplies profits and losses, making strategies like stop-loss orders and maintaining sufficient margin levels essential. Options traders must remember that their premium paid for contracts will be lost completely if their option expires out of the money.

The most important thing is choosing the right trading strategy. Options are flexible regarding their application through Covered Calls, Straddles, and Spreads. But Futures are simple with higher obligations. So, your strategy should align with market conditions to get proper outcomes.

Last but not least, timing and discipline are paramount. The F&O market is volatile, and decision-making without emotional bias becomes vital. Keeping tabs on trades, learning from successes and failures, and being updated on current events become essentials for your habit book.

Overall, F&O trading is the most rewarding for those combining knowledge, strategy, and risk management with disciplined execution.

Pros & Cons of F&O Trading

Trading in Futures and Options (F&O) offers significant opportunities for profit and risk management, but it also comes with challenges. Below is a detailed look at the pros and cons of F&O trading.

Pros of F&O Trading

Leverage: F&O trading allows traders to control large positions with a smaller capital investment, magnifying potential returns.
Hedging Opportunities: Futures and options are excellent hedging tools in volatile markets. It helps protect portfolios from adverse price movements.
Flexibility in Strategies: Options trading provides varied strategies, including Covered Calls, Iron Condors, and Straddles, which enable traders to make money in various market conditions.
Liquidity: F&O contracts are quite liquid, especially for popular assets like indices and blue-chip stocks, facilitating easy entry and exit.
Profit Potential in Any Market: Both rising and falling markets offer profit-making opportunities, and options have an edge in volatile markets.

Cons of F&O Trading

High Risk: Leverage magnifies losses and profits, creating a position of high exposure.
Complexity: Understanding F&O instruments and employing strategies would necessitate advanced knowledge, making it less useful for beginners.
Margin Requirements: Futures trading has margin requirements, and margin calls can arise due to an unfavourable market swing.
Time Sensitivity: F&O contracts have expiration dates, and their value can decrease rapidly as they near expiry, especially for out-of-the-money options.
Emotional Pressure: Its volatility and speed create psychological pressure and induce the tendency for impulsive and damage-causing decisions in F&O markets.

Conclusion

A Future is a right and an obligation to buy or sell an underlying asset at a predetermined price. Options are a right without an obligation to buy or sell equity or index. While a Call Option is a right to buy while a Put Option is a right to sell. Options and Futures are conceptually different but intrinsically same in online trading platform. They act as a hedge since both try to get returns from stock or an index without investing the full sum. You can open a trading account to explore futures and options.

Frequently Asked Questions

1. Which is better, trading futures or options?

It depends on your goals. Futures suit traders who want direct exposure to price movements, while options offer flexibility with defined risks. Options may be better for beginners because of lower initial risk, but futures can provide greater returns for experienced traders. Choose based on risk tolerance and market expertise.

2. What are the risks of trading in F&O?

F&O trading is very risky, with high leverage, margin requirements, market volatility, and time sensitivity for options. Without proper knowledge or strategies, one might incur significant financial losses. Therefore, risk management is paramount for traders.

3. Can Futures and Options contracts be traded intraday?

Yes, it is possible to trade F&O contracts intraday. The daily price fluctuations make many traders profit from trading with such rapidity. However, as the market is highly volatile, it is only possible through close monitoring, knowledge of the market, and strict risk management.

4. What happens on the F&O expiry day?

On expiry day, F&O contracts are settled through cash or physical delivery. Options expire worthless if out of the money, while futures positions must be closed or settled at the final settlement price of the underlying asset.

5. Is F&O trading profitable?

F&O trading can be profitable for skilled traders who understand market dynamics, implement effective strategies, and manage risks. However, high leverage and volatility also mean potential for significant losses, making discipline and experience crucial for consistent profitability.

How to Trade in Futures and Options?