Future&Options

One of the most interesting trading features in the stock market is trading on FUTURE&OPTIONS.

So what basically is FUTURE&OPTIONS or in short (F&O) trading, to understand this we have to first, we have to understand the meaning of it.

FUTURE&OPTIONS are basically Derivative,

So what is a derivative?

Like share, bonds, derivatives are also financial instruments

Derivatives are nothing but Financial instruments which derive their value from an underlying asset.

A Future contract is a legal agreement to buy/sell a particular commodity, asset, security at a pre-determined price at a specified time in the future.

So we have to understand this that the future contract can be based on anything like:-

·         Commodity (gold/silver/etc.)

·         Securities (shares)

·         Even of nifty, there is a future option

Example, So Instead of buying a commodity suppose (gold) we buy/bet on the instruments or contract which has an impact on the movement in the price of gold, it can be either increase in price or decrease in the price of gold.

So, in simple words you are benefited by the movement of the price of the commodity, you don’t have to buy the commodity, you only have to buy it if you didn’t square off your position before the expiry date.

 

EXPIRY DATE?

Yes there is a term used as expiry period/date so basically you have to understand this that a future option is limited / predicted for a specific period in our case most of the future contracts are for 3 months. (terminology.com)

And the date/day for deciding the expiry would have been based on last Thursday of the month in which the contract was contracted,

 

 So if the future contract is of June then the expiry shall be on the last Thursday of the month that is in our case 25/06/2020.

If it was off next month (July) then the expiry would have been of that particular month last Thursday which is 30/07/2020.

And if the last Thursday of the month for any reason is considered to be a public holiday or for some reason, the stock market is not open that particular day, then Wednesday (the day before Thursday) shall be considered to be the expiry date for future contracts.

So does even buying/selling also share to have an expiry date?

The answer is “NO”

 Only future contracts are based on assumptions and they are limited to this expiry date/period. Let’s see a future contract for more understanding:-

 

 

So let’s take an example to suppose we thought of buying a future contract of “ICICI BANK”  as we can see below 3 months future contract are usually traded that is of the month of:-

·         June,

·          July,

·         August

 

Unlike shares future contracts are done in “lot” as seen in the picture, the lot size is 1375 and the price is 349.30 rupees

                

Suppose we got into a future contract and we bought a lot for 349.30 rupees. And let’s say by the end of the month or even before the expiry date we sold / square off our position

 The future contract was sold at a price (just an example) let’s say at 400 rupees then my potential profit shall be of the difference between rupees 349.30 & 400 rupees, which turns out to be rupees 50.7 multiplied into the lot size, therefore (50.7*1375 = 69,712.5 rupees).

One of the features of a futures contract is that it's binding between the parties that mean the buyer and the seller at bound to comply and complete the contract (they cannot refuse to fulfill the contract even if they are making a loss in the transaction since it was pre-determined).

Therefore your gain might be a loss for the other but at the same time, both the parties cannot refuse since it was pre-determined.

So coming up to the point if we didn’t sell off / square off our position with the future contract and we wait till the expiry date which is as already discussed be the last Thursday of the month.

Then there are 2 possibilities:-

1.   Cash-Based Settlement:-

Under the cash-based settlement, the position is automatically squared off and the gain is directly sent to your bank account. 

2  Delivery Based Settlement:-

Under delivery based settlement you have to first take the position of the commodity/ shares for which future the contract has taken place in our example (ICICI BANK)  buying them and then the gain is transferred to you when the future contract is further sold in the open market.

Mostly stockbrokers make sure that the “Cash-Based Settlement” is opted to buy their clients so that easy and quick dealing is done.

Just like shares trading in future the contract also comes with broking charges (brokerage), their charges are very nominal, talking about “ZERODHA” (it’s a discount broker) their charges are:-

·         20 rupees or

·         0.03% of trade volume

Whichever is lower

“So I hope the basic clarifications regarding what are future contracts and what are their benefits by dealing in them are clear to you all, for any queries comment down below and for a recommendation of new topics do let us know what are the topics on which you would want us to come up with”