What is Futures and Options trading?
The trading mechanics behind Options and Futures are similar to other securities but they are slightly different from trading shares. When you trade shares, you exchange the actual underlying which are the equity shares of the company. Whereas, Futures and Options are derivative instruments that are contracts or agreements between the buyer and the seller. These contracts are traded between the buyer and seller as an agreement to exchange the underlying asset on a later date.
Futures Trading
Futures and options are primarily used by traders and also investors for hedging purposes and also speculative activities. Trading in a Futures contract is similar to making a future projection on the price of an asset and taking a bet on it. Here, the buyer and seller of the futures contract have the obligation to exchange the underlying at a predetermined price, and at a pre-defined rate.
Options Trading
Now let’s look at the Options trading basics. Similar to futures, options are mere agreements between the buyer and seller of these contracts. But contrary to futures, where both the parties are under the obligation to exchange the underlying. The buyer of an option has the right but not the obligation to execute the contract. Whereas, the seller of an options contract has the obligation to give or take delivery of the underlying on the date of expiry.
In either case, a trader makes money if the price movement of the underlying happens according to his expectations. For example, if the trader had a short position and the price of the underlying went down, he would make profits. On the other side, the opposite party, the buyer, in this case, will bear the loss.
How to trade Futures & Options in Zerodha?
Zerodha is India’s largest broker, and a majority of the investors must be having an account with them. Therefore let’s learn how to trade F&O(Futures & Options) in Zerodha.
Before we deep dive into how to trade F&O, let’s first look at the requirements to start trading in derivatives.
Derivatives (Futures & Options) are high-risk instruments therefore, there are some minimum requirements that you need to fulfill before you can start trading them.
Basic requirements for trading Futures & Options
The primary requirement for any individual in order to trade futures and options is a Demat account. Assuming you already have a Demat account, let us look at what else you need to activate the F&O segment in your Zerodha account. There are essentially 3 requirements, the first two include proof of identity and proof of address. These are automatically fetched from the details, you mentioned at the time of opening your account. The additional document which you need to provide is the ‘Proof of Income.’ Here are some of the documents accepted as your proof of income.
- Income statement
- Salary slip
- ITR (Income Tax Return)
- Self Worth Certificate
- Demat Holding Statement
- Bank Account Statement of last 6 months.
Once you have provided Zerodha with the required documents, you need to wait for 24 to 48 hours for the final verification. Once your documents are verified, you are all set to trade in derivatives.
Steps to trade Futures
You might think that trading in Futures or Options might be extremely complicated, but you are mistaken. Placing a futures trade is as easy as adding a stock to your watchlist and buying it.
Future contracts are available in 3 options. The most-traded contract is the current month contract, then the next month’s contract and the least traded contract is the far month contract.
Let’s consider the example of TCS to understand it further.
If you want to purchase a Futures contract for the current month, you can buy a ‘TCS FEB FUT’.
In the same way, if you want to hold on to your position for multiple months, you can select the March or April month futures contract. Futures are not complicated as there is only one contract available for a particular month.
Steps to trade Options
On the other hand, Options trading is slightly more tricky. Options contracts have two components; one is the Call option and the other is the Put Option.
And further, there are buyers and sellers of these Call and Put options.
On top of that, there are Options contracts for numerous strike prices of different expiries (Weekly and Monthly).
Let’s take the example of TCS to understand the concept of options trading in a better manner.
Considering the last traded price of TCS, which is around Rs 3730 in the month of February, there are two possibilities with the stock.
- The price will appreciate and end up above Rs 3730 by the end of this month.
- The price will fall and will be lower than the current price of Rs 3730 by the end of February.
Now, once you have taken a future view, you can make money by using options. Let’s assume, you predict that the price of TCS will cross Rs 3800 per share, in that case, you can buy the TCS 3800 CE (Call Option).
On the contrary, if you are bearish and anticipate a correction towards Rs 3700 in the stock price, You can buy a TCS 3700 PE (Put Option).
Henceforth, if the price of TCS increases, the buyer of the CALL option will profit, and in case the price falls, the buyer of the PUT option will benefit from it.
In the following way, you can trade in Options of any particular stock or index. Zerodha provides you with all the liquid strike prices of any derivatives to trade.
Conclusion
Even though Futures and Options trading is risky, you can benefit largely from these instruments by deploying them to hedge your portfolio or to take speculative positions. Either way, traders can benefit from Futures and Options to generate quick returns on the sideline apart from their long-term investments.
