Futures and options
Trade more with less investment
What are Derivatives?
Futures and Options, also called derivatives, are financial contracts between two parties, one of whom is the buyer and other is the seller. There is an underlying asset for each derivative which is either a stock or an index.
Futures and options are themselves traded in stock market. Price of any derivative changes with any change in the price of underlying stock or index. Since derivatives are contracts, they come with an expiry date.
In India, not all indices and stocks listed on a stock exchange are allowed to trade in derivative segment. They are a select few and are chosen based on certain criteria given by stock exchange.
How to Trade in Derivatives?
Derivatives are traded in lots and these lot sizes a decided by the exchange.
You need to open a trading and a demat account to start trading in futures and options. Then you need to link any of your existing bank accounts to transfer money to your trading account.
For buying one lot of futures, you need to have margin money in your trading account. The amount of margin money for every available underlying asset is decided by stock exchange and keeps changing with the change in price of underlying stock or index. Once you transfer required margin money to your trading account, you can buy one lot of futures. To buy two lots of the same futures, you need to have twice the margin amount in your trading account.
You can also go short in derivative segment. Again you need to have margin money in your trading account to sell one fresh lot of futures.
In case of options, you need to pay the premium for purchase. Premium amount is equal to price of the option multiplied by lot size. In case you want to sell a fresh lot of option, which is also called writing an option, you need to have the margin money.
Profit (or loss) in derivatives segment is settled daily on mark to market basis. This will be reflected in your trading account at the end of any business day for each futures or option position you are holding. You can close your open positions in derivatives segment anytime before expiry.
Benefits of Trading in Derivatives
Derivatives are more complex products. Yet they are very popular in indian stock market and command a major share in daily trade volumes in the market.
Leverage: Trading in derivatives requires margin money. This margin money is much lesser that the cost of purchase of actual number of shares of the same underlying asset. Thus you can trade large volumes in derivatives when compared to equity with same amount of investment.
Liquidity: Futures market are highly liquid thank to the large number of trades happening everyday. You can practically buy or sell huge quantities of futures without affecting their prices.
Short Selling: In India, short selling in stocks is not allowed. At the most, it can only be done in intraday trades in equity. Though you can short sell futures or options depending upon your trading strategy. This single feature can be the most useful one in devising short term trading strategies and exploiting fluctuations in the market.
Hedging: You can also hedge your investment in stocks by use of derivatives to reduce the down side risk.