by admin | May 8, 2024
Introduction
Futures and Options refer to financial instruments that are largely traded in stock markets by both new and experienced stock traders. Trades can be made on the price movements of underlying assets, such as stocks, currencies, and commodities, using either of these instruments. But there are distinctions between trading options and futures. In this post, we will delve deeper to know more about futures & options trading and its importance.
Table of Contents
What is futures trading?
Futures are essentially a kind of derivative contract for the future purchase or selling of an asset at a fixed price. Shares of a corporation, commodities, coffee, silver, gold, etc. can all be considered assets. A futures contract involves two parties: a buyer, who holds a long position, and a seller, who has a short position. The buyer of a futures contract commits to purchasing a specific amount of securities or a commodity, while the seller agrees to supply it.
The price of the contract tends to fluctuate over time in relation to the underlying asset’s price. The trader experiences profit or loss as a result of this frequent fluctuation in the contract price. A binding contract between a buyer and seller for the trading of derivatives in accordance with the terms of the agreement is known as futures trading. In futures trading, both buyers and sellers are required to uphold their end of the bargain.
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What is lot size in futures trading?
A lot size in futures trading refers to the smallest ticket size of shares that one can trade in futures. You can only purchase and sell futures and options in minimum lots of one or multiples of the lot size while trading these products.
Futures lot size and options lot size is the same. The notional value of the futures contract is what you get when you multiply the lot size by the price when discussing futures lot sizes.
Why is futures trading done?
There are several advantages of futures trading including:
Betting against the underlying asset is simple – You’ll have access to a larger range of assets when selling a futures contract, and it may be simpler than short-selling stocks.
Simple pricing – The current spot price serves as the basis for futures pricing, which are then modified to account for the risk-free rate of return through expiration and the expense of physically storing the commodities before they are physically delivered to the buyer.
High liquidity – Due to the high liquidity of futures markets, investors can easily switch positions without incurring significant transaction fees.
Easy to hedge positions – You can hedge against downside risk in your business or investment portfolio by taking a strategic position in futures.
Employ leverage – Leverage in futures trading might be higher than in a traditional stock brokerage account. With futures, you could receive 20:1 leverage when with a stockbroker, you might only receive 2:1. Naturally, higher leverage entails higher risk.
Most Traded Futures Contracts
Below are the most traded futures contracts at present.
What is options trading?
Options trading enables investors to make predictions about the future movement of particular stocks or bonds, as well as the stock market as a whole. With an options contract, you have the choice—but not the obligation—to purchase or sell an underlying asset by a specified date at a predetermined price.
A financial contract known as an option gives a trader or investor the right to purchase or sell a benchmark, stock, ETF, commodity, or currency at a predetermined price for a predetermined amount of time. Contracts for options have a set expiration date, which is often the final Thursday of the month. The contract expires and loses all of its value on the designated date of expiry. Options do not require the buyer or seller to uphold their end of the bargain, in contrast to futures.
An investor or trader who holds an option has the right, for a certain period of time, to buy or sell a benchmark, stock, ETF, currency, or commodity at a predetermined price. Options contracts have a predetermined expiration date, which is often the last Thursday of the month. On the specified expiration date, the contract ends and all of its value is lost. Unlike futures, options do not compel either the seller or the buyer to fulfill their half of the agreement.
What are types of option?
There are primarily two types of options: Call and Put.
What is call option?
Before the option expires, the holder of a call option has the option to purchase the underlying asset at the strike price. When an investor believes that the price of the underlying asset will increase, they usually employ call options.
What is put option?
In contrast, the holder of a put option has the opportunity to sell the underlying asset before the expiration date at the strike price. Put options are frequently used by investors who anticipate a decline in the value of the underlying asset.
What is strike price?
When the option is exercised, strike price is the price at which the underlying asset will be purchased or sold.
What is premium?
This is the cost of purchasing the right to purchase or sell the underlying asset and is the amount paid for the option contract.
What is in the money?
This is the sum of money that traders must put down as security when they trade options or futures. If a trade does not turn out as expected, the margin is utilized to offset any possible losses.
What is out of money?
This term refers to a choice that is devoid of inherent worth. When the price of the underlying asset is higher than the strike price, a put option is out-of-the-money, and when it is lower than the strike price, a call option is.
What does ‘At the money’ mean?
An option with a strike price equal to the current value of the underlying asset is referred to by this term.
Difference Between Futures & Options Trading
| Particulars | Futures Trading | Options Trading |
| Gain or Loss | It could have innumerable wins and losses. | It reduces the chance of a potential loss, yet it still has the potential to bring you limitless gain or loss. |
| Risk | They carry higher risks | They carry limited risks. |
| Responsibility | The item must be purchased by the buyer on the designated future date. | This does not require the buyer or the execution of the contract. |
| Advance Payment | When joining a futures contract, there is no entrance cost. Ultimately, nevertheless, the buyer must pay the agreed-upon amount for the item. | A premium is required from the buyer in an options contract. If the asset starts to lose its attraction, the option buyer has the opportunity to choose not to purchase it at a later date by paying the premium. It should be mentioned that the premium paid represents the amount the holder of the options contract expects to lose should he choose not to buy the asset. |
| Contract Execution | A futures contract goes into effect on a specified day. This particular day, the buyer acquires the underlying asset. | Before the option expires, the buyer may exercise the option whenever they like. Because of this, someone is prepared to buy the asset whenever favorable conditions arise. |
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FAQs on Futures and Options Trading
Q.1. Is options trading risky?
Ans:- If a trader does not exercise due diligence with regard to numerous elements such as market circumstances, volatility, continued trend lines, etc., then options trading may be riskier. If the proper strategies for protection and hedging are used, options don’t have to be chancier.
Q.2. What are the 4 types of options?
Ans:- The four types of options are buying call option (long call), selling call option (short call), buying put option (long put), and selling a put option (short put).
Q.3. Is options trading suitable for beginners?
Ans:- Compared to novices, seasoned investors with time to monitor the market and familiarity with it are likely to succeed in options trading.
Q.4. How long can I hold futures?
Ans:- One can hold future contracts till their expiry date.
Q.5. Is future option trading worthy?
Ans:- Future option trading’s suitability for a given investor relies on his investing objectives, risk tolerance, and ability to make wise trading choices. Before engaging in any trading activity involving futures or options, it is imperative to conduct a comprehensive investigation and consult a financial advisor due to the complexity and high degree of risk involved.