FUTURES AND OPTIONS TRADING

Derivatives come handy for protection against price fluctuations. There are two types of derivatives – futures and options. Apart from being a hedge against price fluctuations, they can be traded on exchanges such as commodities, stocks, and currency.

Future and option trading enable those, who are disinterested in the underlying asset to profit from price fluctuations. For example, you are interested in F&O trading of wheat. You aren’t interested in hoarding tonnes of grains in your garage but, are keen to benefit from price fluctuations. Then, you can buy wheat futures and options without getting the commodity delivered to you. Most participants in the F&O market are speculators, who are not quite interested in the product. This is good as it contributes to the market’s liquidity.

Here’s what you should know about futures and options: –

Futures: A futures contract grants the buyer the right to buy a certain quantity of a commodity, and the seller to sell it at a specific price on a fixed date in future. Let’s say a farmer wants to sell his wheat crop. He would want protection against future price fluctuations. In that case, the person will take out a futures contract to sell the produce; say five quintals, at Rs 2,000 a quintal, on a certain date in future. So, the farmer will be able to sell wheat at Rs 2,000 a quintal, even if prices in the market drop to Rs 1,500! The downside is the chance of losses if rates rise to Rs 2,500. Futures are available for a wide range of assets – agricultural commodities, stocks, currency, minerals, petroleum etc.

Options: An options contract gives the buyer the right to purchase a particular asset at a fixed price on a predetermined date. However, it does not leave the buyer with an obligation to do the same. As a result, the buyer has the choice of not exercising his right to buy if prices don’t move in the way anticipated. For example, if a wheat buyer enters into an options contract to purchase 10 quintals of wheat at Rs 2,000 on a specific date, and the price moves up to Rs 2,100 on that date, the person has the choice of not buying. The only charge the buyer must pay is the premium paid to the seller of the contract.

 

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