What Are Futures and Options?
There is a segment apart from the Cash market where the buying and selling of shares take place. Exchanges also allow traders to take part in another segment known as the Derivatives. This Derivatives segment allows market participants to take calls on elements such as Equity, Commodities, and Currencies. One can trade these derivatives through two instruments namely, Futures and Options.
Understanding how Futures and Options work is the very first step into trading the above-mentioned asset classes. If the participant knows what they are doing, this segment of the market can be highly profitable.
Futures and Options were originally created as a Hedging Instrument to transfer risk. Hedging is nothing but taking an opposite call on an asset.
An example of Hedging
This can be better explained with an example. Suppose investor ‘Mr. X’ has been invested in stock ‘ABC’ for 10 years and does not plan on quitting. Now, the government has imposed a new law which the country is not taking kindly to. It is clear that the prices of stocks will fall in the short term. So, instead of selling his holding, Mr. X takes a short call on the futures of Stock ‘ABC’.
This means that the price of Stock ABC falls in the cash market. And at the same time, the short call in the futures of Stock ABC recovers that same loss.
This was a very minute example and there are many factors that come into play. One such factor is that not all stocks in the cash market have their Futures and Options Counterpart.
Additionally, one cannot learn how to trade Derivatives as they are very dynamic instruments. The guidance of an expert is highly recommended as these instruments are highly risky.
All you should take away from this is that derivatives are a different segment from the cash one altogether. If you wish to know more about our course on Derivatives, click here. If you wish to trade professionally in the Currency (Forex), commodity or stock F&O market, then this is the course for you.
Why Trade Futures and Options?
Do you know why participants choose to trade the Derivatives segment rather than the Cash segment? The answer is the potential to make higher returns in a shorter amount of time with a smaller capital.
Going into detail about the Futures & Options will make this post very lomg but one piece to take away is that Derivatives allow traders to trade using margins. This means that the trader can enjoy the profit of trading large quantities of stocks without having to pay for all of them but instead, pay a margin. This margin is a varying percentage of the actual amount and differs across securities.
The potential of making greater profits is high but this comes at a price. Should the trade go against the analysis, the chances of making losses is also great. This is the main reason the trader should be well versed in Technical as well as Fundamental Analysis skills. Without these skills and the understanding of the Derivatives market, the trader must not even dream of entering trades in these segments. Further, with the right knowledge from the right sources, this segment of the market can be highly profitable and many have made it their full-time job.
One huge benefit of the Derivatives Segment
One more big reason why participants trade these segments is that it allows traders to take short calls and carry forward them for more than a day. In the case of the cash market, brokers allow traders to take short calls strictly for intraday trades.
This is the factor of the Derivatives segment that allows Investors to hedge their positions during bad times. It is a fact that the market does not move in one direction solely. There are times when it makes sense that the stock market will correct itself. During such times, investors who want to retain their holdings but do not want to lose money at the same time can Hedge their positions using Futures.
Should You Trade Futures & Options?
Despite people opposing the Derivatives segment, Futures & Options can be highly profitable and helpful if traded correctly. Not only is the trading of Futures and Options the full-time job of many, but even banks and other large institutions hedge their investments by taking part in the contracts of the Derivatives market.
With that, good knowledge of the stock market along with some experience using Technical & Fundamental Analysis is a must before exploring the Derivatives market. The reason these skills are so important is due to the fact that Currencies and Commodities trade on the basis of Technical Analysis most of the time. This means that trading these securities is less risky than trading stocks, and the calls prove to be much more accurate.
Should You wish to get a professional grasp on Technical & Fundamental Analysis, check out this course. Our Wealth Multiplier Course is a combination of Technical & Fundamental Analysis and intends to give the student a complete understanding of the topics. In this course, we begin right from the basics of the stock market and make our way to the advanced level understanding of the same.
What’s more is that we apply what has been taught in the Live Market.
Click here to some of the trades we have taken to get a sense of the accuracy of our strategies.