Essentially, trading is nothing but an art to be able to foresee the future. There is joy (of profits) if we can foresee it right, and a sense of grief (losses) if our views and conviction go wrong. In simple terms, a trader is an individual or entity who buys or sells financial instruments like shares, bonds, derivatives, etc intending to make profits or to hedge the existing position. In this article, we will have a look at what is futures and options trading. Let’s begin with Futures trading.
What is Futures Trading?
Future Trading is a contract between parties to buy or sell a particular stock, commodity or any product at a fixed price on a future date.
Let us understand futures trading with an example:
Suppose Akash and Urmi are friends. Urmi owns a wholesale shop for clothing. Meanwhile, Akash gets involved in a contract with Urmi to buy 250 items at the price of 1 lakh in the next 3 months. Urmi agrees to enter into a contract.
In the next 3 months, either of the following things may happen:
- The price of the items might increase to ₹ 1,20,000 and Urmi might incur a loss of ₹ 20,000.
- The price of the items might decrease to ₹ 75,000 and Akash might incur a loss of ₹ 25,000.
- Or the price of the items might remain the same. (Neither profit nor loss)
In the above Futures Contract, both parties cannot withdraw the contract for 3 months. If any of the parties or both try to withdraw the contract, this will lead to legal implications from either of the parties.
Similarly, in the Stock Market, investors buy stock futures if they expect the price of the stock to increase in the future and short sell if they expect the price of the stock to decrease in the future.
However, unlike the stated example, in the Stock Market Futures Contract, one can exit anytime they want by booking the profits or losses.
What is Options Trading?
Options contracts are quite similar to Futures but with some differences.
To understand the difference better, we need to learn about Options Buying and Options Selling separately.
Option Buying: Unlike Futures Contract, here you will have to pay only the advance amount (premium) to enter into the contract and if the trade goes against you, you will lose the advance amount (premium) only. On the contrary, if the trade goes in your favor, you will make unlimited profits.
Option Selling: Here, you will receive the premium from the option buyer and the profits will be limited to the premium received only. On the other hand, if the trade goes against you, your losses will be unlimited.
The types of Futures and Options Trading
There are 3 types of futures and options in the stock market:
- Equity Futures & Options
- Currency Futures & Options
- Commodity Futures & Options
Futures vs Options
Check out the difference between Futures and Options in the Table below:
| Futures | Options Buying | Options Selling | |
| Meaning | It is a contract between people to buy or sell a particular stock/commodity at a fixed price on a future date. | It is a contract where a buyer pays only the advance amount (premium) to enter into the contract. | It is a contract where you receive the premium from the option buyer and the profits will be limited to the premium received only. |
| Obligation | Both buyer and seller are obligated to buy & sell at an agreed price. | Option Buyer is not obligated as he takes the risk by paying a premium or advance amount before entering into the contract. | Option Seller is obligated as he receives the premium or advance amount before entering into the contract. |
| Advance Payments | No advance payments. | Pays advance payment. | Receives advance payment. |
| Money Required | Requires a higher amount of money. | Requires only a premium amount. | Requires a higher amount of money. |
| Execution | Any date before the expiry. | Any date before the expiry. | Any date before the expiry. |
| Profit | Unlimited profit. | Unlimited profit. | Limited profit. |
| Loss | Unlimited loss. | Limited loss. | Unlimited loss. |
| Risk | High. | Limited to the premium paid. | High. |
Open your Free Demat Account today, and start trading in Futures and Options.
