What are Futures & Options Trading?

Equity shares aren’t the only asset you can trade in the Indian financial markets. In fact, there are others like bonds, debentures, Exchange Traded Funds (ETFs) and derivative contracts. Among the asset classes other than equities, derivative contracts are the most popular.

In India, you can trade in two kinds of derivative contracts via the stock exchange – futures and options. And just like with equity shares, you need an online demat account to trade in derivatives.

Want to know more about futures and options trading? Here’s a comprehensive guide that can help you understand what they are.

What is Futures Trading?

Futures trading is a type of trading where you purchase and sell futures contracts. These contracts are essentially agreements between two parties to buy or sell an underlying asset at a predetermined price on a specific date in the future known as the contract expiration date. Futures contracts expire on the last Thursday of every month.

The futures contract derives its value based on the underlying asset’s value. It is for this reason that futures are termed derivatives. An underlying asset can be a company’s stock, a market index, a commodity or a currency pair. 

Futures Trading – An Example

Let’s look at an example to better understand how futures trading actually works.

Assume that you’re interested in trading in the futures contract of Infosys Limited. Here, the underlying asset is Infosys Limited. The current stock price is ₹1,340 per share, whereas the current price of the futures contract is ₹1,350 per share.

Since you expect the share price to rise in the future, you plan to purchase one lot (400 shares) of Infosys futures at ₹1,350 per share. However, since this is a futures contract, you don’t have to pay the entire trade value of ₹5,40,000 (400 x ₹1,350) upfront. Instead, you just have to pay a percentage (say 20%) of the total trade value as a margin, which comes to ₹1,08,000.

So, you pay the margin of ₹1,08,000 and purchase one lot (400 shares) of Infosys futures on July 03, 2023. Futures contracts expire on the last Thursday of each month, meaning the contract will expire on July 27, 2023.

Now, as the contract nears its expiration date, the share price of Infosys Limited rises according to your expectations. On the date of expiry, both the share price and the futures contract price touch ₹1,450. The total profit you would receive from this trade would be ₹40,000 (400 shares x ₹100 per share).

What is Options Trading?

Options trading is a type of trading where you purchase and sell options contracts. Options give the buyer of the contract the right, but not the obligation to purchase or sell the underlying asset at a predetermined price (strike price) on a specific date in the future (contract expiration date).

Similar to futures, options contracts also derive their value from the underlying asset’s value, which can be a stock, commodity, index or currency. The similarity between the two types of derivative contracts doesn’t end here. The expiration date for all options contracts is also the last Thursday of every month.

There are two different types of options contracts that you can trade in India – call option and put option. A call option gives the contract buyer the right, but not the obligation to purchase the underlying asset at the strike price on the contract expiration date. A put option, meanwhile, gives the contract buyer the right, but not the obligation to sell the underlying asset at the strike price on the contract expiration date. 

Options Trading – An Example

Here’s a hypothetical example to help you better understand how options trading really works.

Assume that you’re interested in trading in the options contract of Reliance Industries Limited. Here, the underlying asset is Reliance Industries Limited. The current price of the stock is ₹2,500 per share.

Now, you expect the share price to fall in the future. Therefore, you plan to purchase one lot (250 shares) of Reliance Industries put options with a strike price of ₹2,500. These options give you the right to sell 250 shares of Reliance Industries at ₹2,500 per share.

However, since this is an options contract, you don’t have to pay the entire trade value of ₹6,25,000 (250 x ₹2,500) upfront to purchase the contract. Instead, you just have to pay a nominal amount per share as a premium. Now, if the premium per share is say ₹40; you just need to pay ₹10,000 (250 x ₹40).

So, you pay the premium of ₹10,000 and purchase one lot (250 shares) of Reliance Industries put options with a strike price of ₹2,500 futures on July 03, 2023. Options contracts also expire on the last Thursday of each month, meaning the contract will expire on July 27, 2023.

Now, as the contract nears its expiration date, the share price of Infosys Limited falls according to your expectations. On the date of expiry, the share price touches ₹2,450. Since you have a put options contract, you have the right to sell your shares at ₹2,500 per share even though the price has fallen to ₹2,450 per share. If you exercise your right, the total profit you would receive from the trade would be ₹12,500 (250 shares x ₹50 per share).

Conclusion

Unlike regular equity trading, futures and options trading is more complex and more suitable for experienced traders. Also, they carry a significantly higher level of risk compared to equities. However, if you still plan on trading in derivatives, remember to apply for an online demat account and a trading account.

Bajaj Financial Securities Limited is a leading stockbroker in India offering trading and demat accounts. With their account, you can trade in derivatives and other asset classes like equities, IPOs and debt instruments. So, what’re you waiting for? Download the Bajaj Securities demat account app today and begin your trading journey.