Future and options
Futures and options are essentially derivatives of other assets that are traded in the markets. In other words, they derive their value from the underlying asset. Futures and options can be derivatives of various assets like equity stocks, commodities or even currencies.
Futures involve an agreement to buy or sell an asset at a predetermined price on a specified future date. They offer both parties a way to hedge against price fluctuations.
Options, on the other hand, provide the buyer with the right (but not the obligation) to buy or sell an asset at a specific price before or at expiry. The seller is obliged to honor the agreement if the buyer chooses to exercise the option.
What is Future and options trading
The next question you may have is ‘What is future and option trading?’ Simply put, futures and options trading is the buying and selling of futures and options. Like their underlying assets, futures and options can also be traded between buyers and sellers.
In this module, we’ll focus purely on futures and options basics and look into what they mean. Also, to get a better understanding of the concepts, we’ll take a look at some theoretical derivative contracts. Let’s start off with the concept of futures.
What is futures
In this Future and options trading we discuss about firstly futures.
In the stock market, futures are basically derivative contracts that obligate a buyer and a seller to trade the stock of a
company at a predetermined price, on a predetermined date in the future. Here, both the buyer and the seller are
obligated to honour their end of the contract.
There are essentially four main elements to a futures contract.
- The obligation of the buyer and the seller.
- The trade of an underlying asset between the two parties.
- The presence of a predetermined price.
- The presence of a predetermined date for the trade to occur.
And as far as a futures contract is concerned, the buyer of the contract is the person who is obligated to buy the asset, while the seller of the futures contract is the person who is obligated to sell the asset.
Another point to note is that the buyer of the futures contract expects the share price to go up. But the seller of the contract expects the share price to fall in the future. And so, both of these parties get into an agreement to effectively lock in the prices.
For Example
Let’s take up Reliance Industries, for instance. Assume that the stock is currently trading at Rs. 1,700 per share. You expect the share price of Reliance Industries to rise in the near future and wish to lock in the current price.
In this case, what do you do? Well, you’ll likely want to buy a futures contract that obligates you to purchase one share of Reliance Industries for Rs. 1,700 at a future date, say one month later.
And since you believe that the price of the share at that point may be much higher, you believe that this futures contract can help you make a profit by allowing you to purchase a share at Rs. 1,700 instead of at whatever higher price there may be at that time.
Meanwhile, Ram, who is another trader, expects that the share price of Reliance Industries will likely fall in the near future. So, what does Ram do? He’ll probably want to sell a futures contract that obligates him to sell one share of Reliance Industries for Rs. 1,700 at a future date, say one month later.
And since Ram believes that the price of the share at that point may be much lower, he believes that this futures contract can help him make a profit by allowing him to sell a share at Rs. 1,700 instead of at whatever lower price there may be at that time.
So, both you and Ram enter into a futures contract that has these four main elements.
You and Ram are both obligated to honour your individual ends of the transaction.
The transaction is essentially the trade of one share of Reliance Industries.
The predetermined price for the stock is Rs. 1,700.
The predetermined date for the trade is one month from today.
Both you and Ram are required to deposit a percentage of the transaction value with your respective stockbrokers to enter into the contract. This amount that you’re required to deposit is termed as the ‘margin.’ Consider this margin as a sort of a security deposit for entering into the contract. And here, Ram, who sells you the futures contract, is obligated to sell the asset. You, being the contract buyer, have the obligation to buy the underlying stock.
At the end of one month, on the predetermined date for the trade, you will have to buy the share for Rs. 1,700 even if it is otherwise trading in the market for a lower price, say Rs. 1,500. Similarly, Ram will also be obligated to sell you the share at Rs. 1,700 even if it is otherwise trading in the market for a higher price, say Rs. 1,800.
What is Options
In this Future and options trading we discuss about now options in briefly.
In the stock market, options are derivative contracts that give the buyer of the contract the right to buy or sell the stock of a company at a predetermined price, on a predetermined date in the future. Here, the buyer has the choice to either buy or sell the asset, while the seller has no such right.
If the buyer of the options contract chooses to exercise their right to buy or sell the asset, the seller of the contract will be obligated to act accordingly.
And if the buyer of the contract chooses not to exercise their right, then the seller will again have to act accordingly. Here, there are essentially four main elements to an options contract.
- The right of the buyer of the options contract.
- The trade of an underlying asset between the two parties.
- The presence of a predetermined price.
- The presence of a predetermined date for the trade to occur.
Unlike a futures contract, here, in an options contract, the buyer of the contract can be either the purchaser or the seller of an asset. In other words, the buyer of the contract can buy the right to either buy an asset or to sell an asset.
f the contract buyer purchases the right to buy an asset from the contract seller, the contract seller then automatically becomes the seller of the asset. And if the contract buyer purchases the right to sell an asset to the contract seller, the contract seller then automatically becomes the buyer of the asset.
Types of option : Call and Put options
In this Future and options trading we discuss about now call and put options in briefly.
With options contracts, there are two different types – call options and put options. This is quite unlike futures contracts, where there’s only one type. Let’s take a look at both of them now.
Call options
A call option contract gives the buyer of the contract the right to purchase the underlying asset at a predetermined price on a predetermined day. In exchange for receiving this right, the buyer of the call option contract pays a certain sum of money known as the premium to the seller of the call option contract.
Put options
A put option contract is the inverse of a call option contract. It gives the buyer of the contract, the right to sell the underlying asset at a pre-agreed upon price on a predetermined day. And as with call options, the buyer will have to pay a premium to the seller for receiving this right.
Examples of Options
To understand options better, we’ll now take a look at a few examples.
Call options – an example
If you happen to visit the call options section of the National Stock Exchange or your trading portal, you will likely see something like this – INFY SEP 1600 CE. This is a typical example of a call option contract of Infosys Limited.
Now, when you purchase this call option, you basically get the right to purchase a set number of shares of Infosys (which in this case is 600 shares) at Rs. 1,600 per share on a predetermined date in the month of September. Let’s say that this options contract is priced at Rs. 200 per share, which is the premium that you would have to pay to the seller to purchase this contract. So, to obtain this right, you will have to pay around Rs. 1,20,000 (Rs. 200 x 600) to the seller.
Put options – an example
Similarly, if you visit the put options section, you will see something like this – TCS NOV 2500 PE. This is a typical example of a put options contract of TCS Limited.
With the purchase of this contract, you essentially get the right to sell a set number of shares (which in this case is 300 shares) of TCS for Rs. 2,500 per share on a predetermined date in the month of November. Now, assume that the contract is priced at Rs. 120 per share. To purchase this contract, you will have to pay the seller Rs. 36,000 (Rs. 120 x 300) as premium. This will give you the right to sell 300 shares of TCS at Rs. 2,500 at a predetermined date in November.
What is option Expiry
In this Future and options trading we discuss about now option expiry in briefly.
An expiration date in derivatives is the last day that derivative contracts, such as options or futures, are valid. On or before this day, investors will have already decided what to do with their expiring position. Before an option expires, its owners can choose to exercise the option, close the position to realize their profit or loss, or let the contract expire worthless.
- Expiration date for derivatives is the final date on which the derivative is valid. After that time, the contract has expired.
- Depending on the type of derivative, the expiration date can result in different outcomes.
- Option owners can choose to exercise the option (and realize profits or losses) or let it expire worthless.
- Futures contract owners can choose to roll over the contract to a future date or close their position and take delivery of the asset or commodity.
Option basics : How to pick the right strike price
The strike price of an option is the price at which a put or call option can be exercised. It is also known as the exercise price. Picking the strike price is one of two key decisions (the other being time to expiration) an investor or trader must make when selecting a specific option. The strike price has an enormous bearing on how your option trade will play out.
Let’s say you are considering buying a call option. Your risk tolerance should determine whether you chose an inthe- money (ITM) call option, an at-the-money (ATM) call, or an out-of-the-money (OTM) call. An ITM option has a higher sensitivity—also known as the option delta—to the price of the underlying stock. If the stock price increases by a given amount, the ITM call would gain more than an ATM or OTM call. But if the stock price declines, the higher delta of the ITM option also means it would decrease more than an ATM or OTM call if the price of the underlying stock falls.
However, an ITM call has a higher initial value, so it is actually less risky. OTM calls have the most risk, especially when they are near the expiration date. If OTM calls are held through the expiration date, they expire worthless.
How to read option data?
In this Future and options trading we discuss about How to read option data in briefly.
For a beginner in Options trading, an Options Chain Chart may look like a complex maze of data. And it may be overwhelming to understand. Browse across forums and trading websites and you’ll find Options Chain to be a subject of many discussions, with many traders asking questions like:
‘How to read a Stocks Options Chain?’
‘How to find Options chain?’
‘How to analyze Options chain charts?’
And so on.
Option chain is an important chart, full of vital information that helps a trader make profitable decisions. If you want to make profitable trades in Options then mastering the Options Chain Chart is a must.
This will help you gain a good understanding of the Options Chain, make sense from the various data available and take the right trading decision.
What is an option chain?
In this Future and options trading we discuss about What is an option chain in briefly.
An Option Chain Chart is a listing of Call and Put Options available for an underlying for a specific expiration period. The listing includes information on premium, volume, Open Interest etc., for different strike prices.
Let’s first see how an Option Chain looks like and understand the various data available in it. NSE provides you with Option chain charts for all trading Options. Here’s what you need to do find the desired Option Chain:
Understanding an option chain:
There are various components of an Options Chart. Let’s understand each component in detail now:
Options Type: Options are of two types; Call and Put. A Call Option is a contract that gives you the right but not the obligation to buy the underlying at a specified price and within the expiration date of the Option. Please remember the contract gives you the right but it is not mandatory for you to buy the underlying. A Put Option, on the other hand, is a contract that gives you the right but not the obligation to sell the underlying at a specified price and within the expiration date of the Option. Here again, the contract gives you the right but it is not mandatory for you to sell the underlying.
Strike price is the price at which you as a buyer and seller of the Option agreed to exercise the contract. Your Options trade will become profitable only when the price of an Option crosses this strike price.
We also on both sides of the strike prices, data like OI, Chng in OI, Volume, IV, LTP, Net Chng, Bid Qty, Bid Price, Ask Price and Ask Qty. let’s understand what each of them means:
OI: OI is an abbreviation for Open Interest. It is a data that signifies the interest of traders in a particular strike price of an Option. OI tells you about the number of contracts that are traded but not exercised or squared off. The higher the number, the more is the interest among traders for the particular strike price of an Option. And hence there is high liquidity for you to able to trade your Option when desired.
Chng in OI: It tells you about the change in the Open Interest within the expiration period. The number of contracts that are closed, exercised or squared off. A significant change in OI should be carefully monitored.
Volume: It is another indicator of traders interest in a particular strike price of an Option. It tells us about the total number of contracts of an Option for a particular strike price are traded in the market. It is calculated on a daily basis. Volume can help you understand the current interest among traders.
V: IV is an abbreviation for Implied Volatility. It tells us about what the market thinks on the price movement of the underlying. A higher IV means the potential for high swings in prices and low IV means no or fewer swings. IV doesn’t tell you about the direction, whether upward or downward, movement of the prices.
LTP: It is the abbreviation for Last Traded Price of an Option.
Net Chng: It is the net change in the LTP. The positive changes, means rise in price, are indicated in green while negative changes, decrease in price, are indicated in red.
Bid Qty: It is the number of buy orders for a particular strike price. This tells you about the current demand for the strike price of an Option.
Bid Price: It is the price quoted in the last buy order. So a price higher than the LTP may suggest that the demand for the Option is rising and vice versa.
Ask Price: It is the price quoted in the last sell order.
Ask Qty: It is the number of open sell orders for a particular strike price. It tells you about the supply for the Option.
We need to first learn ITM, ATM, and OTM.
In-The-Money (ITM): A call option is in ITM if its strike price is less than the current market price of the underlying asset. A put option is ITM if its strike price is greater than the current market price’ of the underlying asset.
At-The-Money (ATM): When the strike price of a Call or Put option is equal to the current market price of the underlying asset then it is in ATM.
Over-The-Money (OTM): A call option is OTM if the strike price is greater than the current market price of the underlying asset. A put option is OTM if the strike price is less than the current market price of the underlying asset.
FAQs
- What is the basic knowledge of future and options?
Futures and options are financial contracts allowing buying/selling of assets at agreed prices, providing hedging/speculation opportunities in markets.
2. What is the connection between futures and options?
Futures and options are both derivatives, but they differ in their structure. Futures obligate parties to buy/sell assets, while options offer choice. Both enable risk management and speculation in financial markets.
3. How do you Analyze future and options?
Analyzing futures and options involves studying underlying asset fundamentals, conducting technical and fundamental analysis, assessing volatility, understanding option Greeks, implementing risk management, and developing trading strategies. Stay informed, practice with virtual accounts, and continuously adapt your approach based on market conditions and experiences.