Investment in equities is considered to be a riskier affair. But it is rewarding as well. There is a famous saying that the lower the risk, the lower the returns, while with high returns comes high risk. To generate high returns, one has to make investments carefully to generate a good income.
There are different ways in which a person can make a good profit from the stock market. Apart from buying and selling stocks in cash, there are several other ways in which one can make money. One of these ways is called a derivative. The derivatives are traded at a price based on their underlying asset. This underlying asset can be a stock or a commodity. There are two types of derivative contracts: futures and options.
A trade is executed only when two people, a buyer and seller, enter into a derivative contract where they agree to sell or buy, or vice versa, the underlying asset at a certain price target within a time range.
Earlier this year, capital market regulator SEBI said that 9 out of 10 individual traders were making losses in the F&O segment.
Notably, India is the world’s largest market for trading in equity F&O. According to a SEBI report, F&O trading has seen a stupendous five-fold growth in less than four years between FY19 and FY22.
A person can buy the options or futures of a stock or index for a certain expiration date. In F&O trade, at the time the price target is achieved, a person makes good profits, whereas not reaching the strike price or target price can vanquish all capital.
A future contract obliges the trader to buy or sell the underlying asset at a specified price at a specified time. The futures are purchased in the form of lots, and one has to pay a margin set by the brokers to enter into the contract.
In an option trade, unlike futures, options give you the right but do not oblige you to sell or buy the contract at a certain price. In other words, when a person enters into an options contract for a certain strike or target price, he or she can exit the contract before reaching the target.
There are two types of options: call and put. A person buys a call option when he aims for the price to reach a certain target that is experiencing an up move. As the price of the stock reaches near the strike price, the premium’s value increases. Whereas in the sell option, as the price of the stock goes away from the strike price, the premium price decreases. A put option is traded when a trader aims for the price of the stock to fall and reach a certain target.