Future and options are financial contracts or tools to trade in the derivatives market. These two types of arrangements offer a huge potential for profits between the buyers and sellers of an asset. Here we explain Futures and Options and how you can use a combination of these to manage your risks.
A Futures contract wherein you have the option to buy and sell an asset or a commodity at a predetermined price at a specific time in the future. In futures and options (no) trading, a future contract asset can be commodities, stocks, currencies, interest rates, or bonds. The quantity of the purchase is predefined too.
An options contract has two options: call option and Put Option. A trader who wants to trade in options can buy a stock at the call option or sell the stock at the put option. An Options contract gives you the right to buy or sell a stock but not an obligation.
FNO Trading Strategies
Any trading market is volatile, as is the case with derivative trading. The futures and options trading is bound to bring gains and losses to others. Here we bring you some future and options trading strategies so you have a good risk management tool for trading.
1. Long Futures – Buy Put
When an investor decides to buy long futures, he is looking for a long position. They want to profit from the rising market. A Long Futures- Buy Put combination is used wherein the investors also provide for the downside.
An investor purchases the January Index Futures Contract, which contains 100 shares for ₹ 5000 each. The total contract value is ₹ 5 Lakhs, and the investor pays a margin of ₹ 50,000. The investor is bullish yet worried about the losses if the market falls.
The investor decides to hedge the downside risks by using the options contract. He buys another 100 near-month NIFTY options contracts expiring in January at a strike price of ₹ 5000. The premium contract comes out to be ₹ 50,000 (₹ 500 per put for 100 puts).
If the NIFTY rises to 5600 points, the investor makes a profit of ₹ 60 000. The only loss will be the premium on puts.
On the contrary, if the NIFTY falls to 4800 points, the investor makes a loss of ₹ 20,000. In this way, you hedge the losses by buying a put option.
2. Short Futures – Buy Call
At times investors do feel like going bearish. Though the instances of markets going bearish are less than those going bullish. But if the reverse happenss, s the upside risk is high. In such a case, you can choose the call option for the upside potential of the stock you have bought.
An investor goes short on a 3-month stock future of a company at ₹ 200 containing 200 shares. The value of the contract becomes ₹ 20,000. The investor pays an initial margin of ₹ 2000. He buys 60 call options of ₹ ten each at an exercise price of ₹ 200. The premium cost becomes ₹ 600.
If the stock prices fall to ₹ 170, the investor makes a profit of ₹ 3000 but loses the premium of ₹ 600.
But surprisingly, the stock price to ₹ 210. The investor has a call backing and hence saves on the losses.
3. Calendar Spreads
A calendar spread is a strategy which an investor buys and sells stocks simultaneously. The contracts have different expiration dates, but the strike price remains unchanged. The short is hedged with a long. He might sell the near-month contracts and buy the long-dated futures.
Futures contracts are a useful risk management instrument. Ideally, you should be cautious and assume hedged positions. When using these combinations for futures and options trading, you need to be an experienced investor. It is difficult for a novice to trade in such combinations and should be avoided by them.