Futures and Options are types of derivative instruments used in the financial markets. They derive their value from an underlying asset like stocks, commodities, currencies, or indices.
Here's a simple breakdown :-
🔹 What is a Future?
A Future is a contract to buy or sell an asset at a fixed price on a specific future date.
- Example :- You agree today to buy 100 shares of a company at ₹500 per share on a date two months from now.
- You are obligated to complete the transaction on the contract date, whether the market price goes up or down.
Key Features :-
- Traded on exchanges.
- Standardized contracts.
- High risk if the market moves against your position.
- Used for speculation or hedging.
🔹 What is an Option?
An Option gives the right but not the obligation to buy or sell an asset at a fixed price before or on a specific date.
There are two types of options :-
1. Call Option - Right to buy the asset.
2. Put Option - Right to sell the asset.
- You pay a premium to buy an option.
- If the market doesn’t move in your favor, you can let the option expire and lose only the premium.
Example :-
- You buy a call option for ₹10 per share to buy stock at ₹500.
- If the stock rises to ₹550, you can exercise the option and profit.
- If it stays below ₹500, you don't exercise it your loss is limited to ₹10.
✅ Quick Comparison :-
Feature :- Obligation
Futures :- Yes
Options :- No (only right, not obligation)
Feature :- Risk
Futures :- Unlimited
Options :- Limited to premium paid
Feature :- Cost
Futures :- No upfront cost (but margin)
Options :- Premium must be paid
Feature :- Use
Futures :- Hedging & Speculation
Options :- Hedging & Speculation
📘 Futures - Detailed Explanation
🔸 What Is a Future Contract?
A Futures contract is an agreement between two parties to buy or sell an underlying asset at a predetermined price on a specified future date.
These are standardized contracts traded on regulated exchanges like the NSE (National Stock Exchange) or BSE (Bombay Stock Exchange) in India.
🔹 Key Terms :-
- Underlying Asset :- The asset being traded (e.g., stocks, commodities, indices).
- Contract Size:- The number of units per contract (e.g., 75 shares in an Nifty Futures contract).
- Expiry Date :- The date when the contract will be settled.
- Mark-to-Market (MTM) :- Daily settlement of profit and loss.
🔹 Example of Futures :-
Suppose you expect Reliance stock to rise. It is currently at ₹2500.
- You enter into a Futures contract to buy Reliance at ₹2500 one month from now.
- If the price goes up to ₹2700 on expiry, you earn ₹200/share.
- But if it falls to ₹2300, you lose ₹200/share.
- You must buy or sell as agreed you can’t walk away.
📘 Options - Detailed Explanation
🔸 What Is an Option Contract?
An Option gives the right, but not the obligation, to buy or sell an underlying asset at a set price within a certain time.
You pay a premium to enter this contract.
🔹 Two Main Types of Options :-
1. Call Option - Right to Buy the asset.
2. Put Option - Right to Sell the asset.
🔹 Key Terms :-
- Strike Price :- The agreed-upon price for the asset.
- Premium :- The price paid to buy the option.
- Expiry Date :- The last date you can exercise the option.
- In the Money / Out of the Money :-
- In-the-money: Profitable if exercised now.
- Out-of-the-money: Not profitable yet.
🔹 Example of Options :-
Call Option :-
You buy a Call Option for Infosys at ₹1500 (strike price), paying ₹20 premium.
- If Infosys rises to ₹1600 before expiry :-
- You can buy at ₹1500 and sell at ₹1600 = ₹100 profit.
- After subtracting the ₹20 premium = ₹80 net profit.
- If Infosys stays below ₹1500 :-
- You don’t exercise the option.
- You lose only the ₹20 premium.
Put Option :-
You buy a Put Option for HDFC at ₹2500, paying ₹30 premium.
- If HDFC falls to ₹2400 :-
- You can sell at ₹2500 and buy at ₹2400 = ₹100 profit.
- After premium: ₹70 net profit.
- If HDFC stays above ₹2500 :-
- You don’t exercise.
- You lose only ₹30.
📊 Differences Between Futures and Options
Feature :- Obligation
Futures :- Must buy/sell on expiry
Options :- Can choose to exercise or not
Feature :- Risk
Futures :- Unlimited loss
Options :- Loss limited to premium paid
Feature :- Profit Potential
Futures :- Unlimited
Options :- Unlimited (Call) / High (Put)
Feature :- Premium
Futures :- No premium (but margin required)
Options :- Premium paid upfront
Feature :- Hedging
Futures :- Very effective
Options :- More flexible
Feature :- Liquidity
Futures :- Highly liquid in major contracts
Options :- High in popular strike prices
🛡️ Why Use Futures & Options?
🔹 Hedging :-
- Farmers hedge crop prices.
- Importers hedge currency risk.
- Investors hedge stock portfolios.
🔹 Speculation :-
- Traders bet on price movement for profit.
- Can use leverage (small margin for large exposure).
🔹 Arbitrage :-
- Make profit from price differences between cash and derivatives markets.
⚠️ Risks Involved
- Futures :- Can lead to large losses due to leverage and daily settlement (MTM).
- Options :- Buying has limited risk, but selling options (writing) can be very risky.
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