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Things to be aware of before trading in futures and options

One of the biggest truths about dealing with the share market is that prices of financial instruments such as shares, mutual funds, commodities, etc. will continuously change. This could either mean profit or loss for traders and investors. While every investor invests intending to book a profit, there is an equal chance of incurring losses as well. But you can protect your investments from incurring losses by resorting to derivatives and grasping the F&O basics right.

How to trade in futures and options? What is it all about? Let us learn them in detail.

Overview

Futures and options are essentially derivatives that derive value from an underlying asset. Derivatives are available in different types of assets, including commodities, indices, and stocks. F&O contracts are typically used for two purposes – for hedging and speculating the financial products' prices. These prices could be volatile and result in both profits and loss for investors, traders, and producers.  

Futures contract

It is a derivative in which buyers and sellers agree to buy or sell a specific quantity of the specific asset at a predetermined quantity of a certain asset at a specified price at a scheduled date in the future. This contract helps investors evade the risk levels in the financial instrument's price when they seek to sell the products. Under the futures contract, the buyer or seller should honour the trade.

Options contract

Option trading offers the trader the choice to buy or sell a specific quantity of an asset at a fixed price on a scheduled date in the future. There are two types of options – call and put. The call and put, respectively, gives the buyer the right to sell or buy a specific asset at a fixed price on a scheduled date individually.

Things to consider:

Dealing with futures

Many investors consider trading in futures as an advantage as opposed to cash market buying. This is because you can easily leverage your investment by buying futures on margins. However, you need to remember that the margin can increase sharply, especially when it is volatile.

Dealing in options

Any expert will tell you that option trading comes with limited risks. But the disadvantage here is you can hardly make any money if the risk levels are minimal. Generally, when you trade in futures & options, you limit your risk to your premium. The primary concern here is that many options expire worthlessly, and if you buy options, you stand a little chance of earning profits. In hindsight, you can earn higher returns as an option seller because the risk levels are higher here.

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