In the stock trading, Futures and Options are two popular types of financial contracts used for speculation, hedging, or investing. While they might seem complex at first, understanding them can offer investors ways to manage risk and potentially earn profits. Let’s explore what these terms mean in simple terms.
What Are Futures?
A Futures contract is an agreement to buy or sell an asset at a specific price on a predetermined future date. These contracts are standardized and traded on exchanges. The key point about Futures is that both parties are obligated to fulfill the contract at the agreed-upon time and price.
For example, if you believe that the stock of Company A will rise in the next 3 months, you could buy a futures contract to purchase the stock at today’s price. If the stock price increases by the contract’s expiration date, you make a profit. However, if the price drops, you incur a loss.
What are Options?
An Options contract gives you the right, but not the obligation, to buy or sell an asset at a specific price within a certain period. There are two types of options:
- Call Option: The right to buy.
- Put Option: The right to sell.
You pay a premium to purchase the option. If the market moves in your favor, you can exercise the option or sell it for a profit. If not, you can let the option expire worthless, losing only the premium you paid.
Example of Futures and Options:
Futures Example: You buy a futures contract to purchase 100 shares of Company X at ₹100 each, with a contract expiry in 3 months. If, after 3 months, the stock price rises to ₹120, you can sell the contract at the higher price and make a profit of ₹20 per share (₹120 – ₹100). If the price falls to ₹80, you lose ₹20 per share.
Options Example: You buy a call option for ₹5 premium with the right to buy 100 shares of Company X at ₹100 in 3 months. If the price rises to ₹120, you can exercise the option and buy at ₹100, making a profit of ₹20 per share, minus the ₹5 premium you paid, for a net profit of ₹15 per share. If the price stays below ₹100, you let the option expire and lose only the ₹5 premium.
Conclusion:
Futures and Options offer exciting opportunities for traders but also carry significant risks. Futures obligate both parties to fulfill the contract, while options offer flexibility with limited risk (limited to the premium). Both are valuable tools for hedging, speculation, and enhancing returns, but they require careful understanding and strategic planning to use effectively.
– Ketaki Dandekar (Team Arthology)
Read more about Futures and Options here – https://groww.in/p/futures-and-options