Futures and Options are derivative instruments that derive their values from the underlying stock, bond, security, commodity, exchange rate, currency or interest rate. Both are capable of providing high returns but are also susceptible to high risk. As derivative instruments, both have gearing, which means if the underlying asset moves x times either upward or downward, Futures and Options instruments are capable of moving multiples of x times.
Futures and Options strategies should be used as a hedge rather than being used as an uncovered strategy. When you have a physical holding of shares, you could use a Futures and Options strategy to either lock in profits or hedge your position. Most investors believe that you have to pay Options premiums for buying options or enter into a contract and pay only initial margins in the case of Futures. So, as an investor, you may feel that you can leverage your capital multiple times. But this is a misleading notion. The exponential effects of a Futures and Options strategy could mean that your losses also multiply exponentially. So, you need to trade cautiously in Futures and Options through your options trading app on your online platform.
If you hold TCS shares at Rs 1600, you can enter into a Futures contract to sell TCS shares at Rs. 2,200. The profit of Rs 600 per share is locked in irrespective of the gyrations the stock undergoes in the interim period. Similarly, if you hold ICICI bank shares at Rs. 750, you can sell a put Options for Rs. 730. If the price of ICICI Bank falls below Rs.730, your holding is protected against all losses below that price by your put Options price.
Similarly, you can buy or sell Index Options or Futures to hedge your stock portfolio so that you hedge your stock portfolio given their uncorrelated movements. However, you should ensure that the Index stock Options or Futures is closely aligned with your stock portfolio.
GIven below are a few points that you can consider when opting for Futures and Options strategy.
- Get all the key parameters of the contract correct: The strike price, the Options premium and the expiry of the Futures and Options contract must all be correctly entered. A near expiry is pricier than a far-off expiry. Also, ensure that you have adequate capital to cover the initial Options premium or initial Futures margin and any unexpected losses in your position. You can easily enter into an Options and Futures contract through your Options trading app when you are undertaking online trading.
- Set your profit goals and maintain stop losses: Don’t let greed overcome fear when you are undertaking simple online stock trading or Futures and Options contracts. Chasing unlimited profits and not keeping appropriate stop losses will leave you unprotected and exposed to the possibility of large losses if there are sudden trend reversals. You need to use your Options app to set profit goals and maintain stop losses when you are undertaking online trading.
- Identify the correct stocks and undertake futures and options contracts in them: You need to study the price trends in the underlying asset and take correct positions through an Options and Futures contract. Doing your homework is paramount before you take up a position. Your Options app on your online trading platform can be used for this purpose.
- Understand the strategy: Options and Futures are not for beginners and the faint-hearted. There is a risk of enormous capital loss if you choose the wrong strategy, the wrong underlying instrument or the wrong elements of the contract. Options are optional derivative instruments where the seller of a contract can face unlimited potential loss. In a Futures contract, both buyers and sellers face the probability of loss. Options can be rolled over to the next expiry at a different price, whereas Futures can be rolled over at the same price to the next expiry. Your Options app on your online trading platform is at your disposal whenever you feel competent to undertake an Options and Futures contract.
