Futures and Options explained
October 28th, 2009
Futures and options are the derivative instruments in which the buyer and seller enter into an agreement or transaction which will get settled on a future date. In simple terms it is a promise between buyer and seller to transfer the actual underlying assets (commodities, gold, stock, currency etc) on a specific future date at a specific stipulated price as per the agreement.
To understand this in a better way, let’s have a look at the below comparison chart between futures and option:
| Futures In futures contract the buyer and seller enter into an obligatory agreement to exercise the contract at maturity. Both the buyer and seller have the obligation to exercise the contract which means on maturity, seller will transfer the underlying securities and buyer will make the cash payment as per agreed price. The buyer does not have to pay any amount for buying a futures contract because it is an enforceable agreement which will get settled on maturity date. Example of future trading: A person bought a futures contract to buy security A at a price of Rs 500 on a specific future date. On the expiry date, the price went up to Rs 600. So the deal is good for buyer who will get the securities at Rs 100 lesser than the actual market price. On other side, it is devastating for the seller who is obliged to sell them at lower price which has been agreed upon. |
Options In options contract the buyer is given an option to decide whether or not he wants to exercise the contract at maturity. Buyer of the contract has the option to exercise it anytime on or before expiry but seller has the obligation to exercise it. If buyer demands to buy the asset, seller will have to sell it. Options are of two types: Call option: It gives the buyer, the right to buy the asset at a strike price. Put Option: It gives the buyer a right to sell the asset at the ‘strike price’ to the buyer The buyer has to pay an amount called as “Premium” for acquiring an additional right of having an option to exercise the contract or not. Example of option trading: A person bought a call option at a strike price of Rs 100. On maturity the price falls to Rs 80. He will not exercise the contract because he can buy the same asset from the market at Rs 80. However if price rises, he will exercise the contract. Similarly, a person bought a put option at a strike price of Rs 100. On maturity the price shoots up to Rs 150. He will not exercise the contract because he can sell the same asset in the market at Rs 150, rather than giving it to the seller at agreed upon price of Rs 100. In both cases, he just lost his premium amount which is marginal. |
From the above description, it can be inferred that be it future or an option; these are the ways of hedging the risk of investments. It provides a protection against unexpected rise or fall in the price by entering into an agreement to be executed in future date. The concept is very old when agreement used to be made by negotiating the price for harvest of season having been unaware whether harvest will be meager or plentiful. When harvest time came, demand would rise sharply and ultimately giving the holder of agreement a chance to earn more than what he had expected.
Whatever be the case, playing options and futures has always been a risky. So better be careful before you enter into the arena!!
Renuka Kinger
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Categories: Trading Basics, Your Money
i am learn more about it
very nice article……i enjoyed it
Dear Renuka
your are fantastic i have did my specialisation in international finance but had problem with this to undertand but now i have a very clear idea of it. thank you……
Good. nice article
very easy and understandable language
Could anyone pls explain me How to start with share trading..?
Reading it when ever i get some doubts… Thanks you
Very good Artical to understand Future and option in Share market
Very well written !!!!!!!!!!
explined beautifully. even a lay man can understand
A good attempt to explain the F&O corner. But according to the definitions and examples, it can be assumed that options may not be much more prevelant cuz both the parties have option to abort the agreement due to floatation in rates.
Nice article, simple and easy to understand a relatively complex concept
Article is very much informative.
thank u,but please give more information abt options. Because I ‘ ve a doubt in that.
Nice article, simple and easy to understand a relatively complex concept
very nice article please keep writing more and more about future and options
thanks a lot
Nice and in Simple Way Explanation. Thank you. God Bless you.
It is good article, but need more information about F& O
please tell me how to start with share trading first
very excellent work for understanding.
as above example i understand little bit, can somebody give other exp for the same so i can easily update.
Plsese co-operation with me if you have knowedge of F&O trading.
Nice place to start from Ground Zero… Thanks Renuka.
nobody can get a better, easier and more useful trading info and guidance than it.
Can you present some examples with real market prices for futures , options ( call and put). That data would certainly help and also mention your website for reference if any to know more on this subject i.e. Futures and Options.
can i know what education u have pursued? Your articles are really useful and knowledgeable. i wuld like to be in your field. pls do reply
Thanks Sayali. I am glad to know that my articles are useful for the readers. Basically I am an engineering graduate in Civil discipline from PEC, Chandigarh and currently working in software industry. Formally i do not have any finance background but since i am very much interested in stock markets and finance related stuff i am in constant touch with the finance field.
So as far as my field of work is concerned, it is not finance but i would anyway be there to clear all your doubts. Please feel free to ask anything you wish to.
Renuka
Hello
How are you ? Your articles on Financial Market are really helpful and easy to understand. thanks for this. I really liked article on Future and Options. Can you provide more information on that topic like open interest(OI), example of F & O calls.
I have 1 example, can you explain that.
Sell Nifty Future @5330/40/50 SL 5380 Target 5300/5290/5280 & Buy 5300 Put @ 65 /70/75 SL 58 Target 90/100.
Hello Renuka
Please answer my above question.