Futures and options are two types of investments that can be made in the volatile world of stock markets. When compared to buying stocks directly, these products let you get into the market with less money at the start. However, it’s important to know how they work before you go in.
Therefore, in this post, I will explain to you in the easiest way with an example, what are futures and options? And how can you invest in it?
Futures
Imagine you have a magic crystal ball that can predict the price of your favorite chocolate bar. Let’s say it’s worth ₹50 today, and your crystal ball tells you it will be ₹60 in a month. You might want to lock in that price today, right? Futures allow you to lock in this future price today in the stock market.
Futures are derivatives that let you buy or sell an asset (like a stock, commodity, or even chocolate) at a specific price at a future date. Unlike buying the actual asset, futures contracts have a fixed expiration date.
For example, you could buy a “Reliance Industries Limited Future” contract, agreeing to buy each Reliance share at ₹2,000 in one month. If the actual price goes above ₹2,000, you earn a profit. Conversely, if it’s below ₹2,000, you incur a loss.
Options
Now let’s talk about options. Think of options as special contracts offering the right, but not the obligation, to buy or sell an asset at a specific price by a specific date.
For example, you can buy a “Tata Motors Call Option” which gives you the right to buy shares of Tata Motors at ₹300 per share within the next three months. However, if the share price does not rise above ₹300, you do not need to buy them; it’s your choice.
Trading in futures and options is like buying and selling some land. Let us assume – you have to buy land. Whose value is Rs 1,00,000 and today you have given Rs 5,000 as premium and promised to the seller that you will buy this land by paying the full amount at the end of the month. But you feel that you will incur loss by purchasing land at the end of the month, so you do not want to buy it. The same happens in option trading, in which you have the choice whether to buy that stock or not, but in future trading you are forced to buy, you cannot refuse.
Read More: 10 Smart Steps to Conquer the Stock Market (save savings)
Key Points to Consider Before Trading
1. Learn the Basics: Before you start trading, educate yourself about futures and options. Understand how they work, what their risks and rewards are. Should you start with futures and options in the beginning or not?
2. Choose a reliable broker: Select a reliable stock broker with a good track record. A good trading platform helps you trade faster. And there should be such a broker who charges less fees from you but at the same time his platform is also good.
3. Risk Management: Decide how much investment and risk you are willing to take. Never invest all your money in one business. Take risks carefully, you have to last long in the market. So invest as much of your capital as you can afford to risk. Suppose you have a capital of Rs 10000 for investment, then you should learn by investing only Rs 3-5 thousand in futures and options. And also pay attention to how much loss you can bear, that is, if you invest Rs 5000 then Rs 500-600, if it comes down then you will sell it and get out. Determine your risk tolerance (acceptable loss amount) and exit strategy beforehand.
4. Analyze the market: Keep track of market trends, news and company performance. This will help you in taking informed decisions.
5. Practice with Virtual Trading: Most brokers offer virtual trading platforms, where you can practice without risking real money. This is an excellent way to gain experience and understand market dynamics before entering the real market.
Example
Imagine you are “XYZ Ltd.” Are following. The stock, which is currently trading at ₹100 per share. You anticipate it will rise, so you buy an “XYZ Limited Call Option” at ₹110 with an expiry date of one month. If, at the end of the month, shares of XYZ Ltd. are trading at ₹120, you can exercise your option, buy the shares at ₹110 and sell them at ₹120 for a ₹10 per share profit.
On the other hand, if you had bought the “XYZ Ltd. Futures contract at ₹110 and the share price fell to ₹90, you would have lost ₹20 per share.
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Conclusion
Futures and options can be very useful for investing, but they also come with a lot of risk. It is very important to approach them with understanding and care. Remember that investing in the stock market comes with risks, so you need to be ready for both possible gains and losses. Start small, get some practice, and as your confidence grows, add more to your collection.
