Stock market investors often think they can only profit when markets rise (e.g., buying ITC at 300 rupees and selling when it rises).
However, profits can also be made in sideways or declining markets.
Introduction to Futures and Options as a way to navigate different market conditions.
1. Underlying vs Derivative
Underlying: An asset with intrinsic value (e.g., an Apple).
Derivative: A financial instrument derived from an underlying asset (e.g., Apple Juice made from an Apple).
Financial Example: Stocks like Nifty50 or Reliance are underlyings; Futures and Options are derivatives based on these.
2. Types of Derivatives
There are many types of derivatives, but mainly four from a stock market perspective:
Forwards
Futures
Options
Swaps
In India, Futures and Options are the most popular.
3. Understanding Futures Contracts
Definition: A contract to buy/sell an asset at a predetermined price at a future date.
Example:
Two parties lock in a price for wheat (5 rupees today for sale at 6 rupees in the future).
If prices rise or fall, the contract must be honored, leading to potential losses or profits for respective parties.
4. Options Overview
Options Definition: Financial derivatives giving the buyer the right, not the obligation, to buy/sell an underlying asset at a predetermined price and date.
Example of a Real Estate Purchase ⪠Token money can be seen as an option deposit to secure the right to decide later.
Types of Options:
Call Option: Gives the holder the right to buy.
Put Option: Gives the holder the right to sell.
5. Purpose of Derivatives
Hedging Strategies: Using derivatives to minimize risk (e.g., JP Steel and Maruti securing steel prices).
Speculation Strategies: Attempting to profit from market fluctuations; riskier approach.
Important note: 95% of traders lose money due to speculation.
6. Using Options for Insurance
Buying options can act as insurance against price fluctuations.
Two types:
Call Option (right to buy)
Put Option (right to sell)
7. Key Terms in Options Trading
Strike Price: Agreed-upon price for the underlying asset.
Premium: Cost to purchase the option, akin to insurance.
Expiry: The date the option is valid; can be weekly or monthly.
8. Trading Options
Example using Nifty options:
Strike Price: 14,900
Premium: 2,792
To profit, the underlying asset must exceed the aggregate sum of strike price and premium.
Final Thoughts
Use Futures and Options primarily for hedging risk, not for speculation.
Educate oneself further on trading strategies without jumping directly into risky speculation.
Important Reminder
Practical use: Top investors often hold actual stocks and hedge with options to protect their portfolios.
Next Steps
Explore advanced courses for deeper knowledge and understanding depending on interest level.