F&O or F&O trading is one of the most versatile and complex trading mechanisms in the financial markets today. It allows traders to speculate on the price movements of an asset in the future, giving them opportunities to maximise returns without directly owning the asset. Whether you are looking into F&O stocks or commodities, understanding the various aspects of F&O trading is essential.
What are Futures and Options?
In simple terms, futures and options are contracts that derive their value from the price of an underlying asset. When you engage in F&O trade, you are either buying or selling these contracts, predicting price changes in the future.
- Futures: This is a commitment to buy or sell an asset at a set price on a future date.
- Options: Unlike futures, stock options trading gives you the right, but not the obligation, to buy or sell the underlying asset. You can opt not to execute the trade if market conditions are unfavorable.
If you are wondering what is the difference between futures and options, the distinction is that futures are obligatory contracts, while options offer flexibility.
Key Terms Used in F&O Trading
F&O trading is a complex area of the stock market, and understanding its key terms is essential for anyone interested in this type of trading. Below are some of the most important concepts you should be familiar with before engaging in F&O trading.
Derivatives
F&O contracts are derivatives, meaning their value is derived from an underlying asset such as stocks, commodities, or currencies. In derivative trading, you do not own the asset directly. Instead, you speculate on its future price based on these derivative contracts.
Futures Contracts
A futures contract is an agreement between two parties to buy or sell an asset at a predetermined price on a specific future date. Both the buyer and seller are obligated to execute the contract at its expiration, regardless of the market price at that time.
For example, if you buy a futures contract to purchase 100 shares of a stock at ₹100 each, you must complete the trade on the expiry date, even if the stock price has changed.
Options Contracts
An options contract is another type of derivative that provides the buyer the right, but not the obligation, to buy or sell an asset at a fixed price within a specified time frame. Options are of two types:
- Call Option: This gives the buyer the right to purchase the asset at a set price.
- Put Option: This gives the buyer the right to sell the asset at a set price.
The key advantage of options trading is that the buyer can choose not to execute the contract if the market price is unfavorable, limiting potential losses.
Strike Price
The strike price is the pre-agreed price at which the underlying asset will be bought or sold in an options contract. For a call option, the strike price is where the buyer can purchase the asset, and for a put option, it is where the buyer can sell the asset.
Premium
When trading options, the buyer pays an upfront cost called a premium to the seller. This premium grants the buyer the right to buy or sell the asset as per the contract. If the buyer chooses not to exercise the option, they lose only the premium, making options trading less risky than futures.
Expiry Date
Every futures and options contract comes with an expiry date, which is the last day on which the contract can be traded. In futures trading, both parties must fulfill the contract obligations on or before this date. In options, the buyer can choose to exercise their right before the expiry date.
Lot Size
In F&O trading, contracts are not traded for single shares but in predefined quantities known as lot sizes. For example, a lot size for a particular stock might be 100 shares, meaning you can only trade multiples of 100 in futures and options.
Margin
In futures options trading, traders are required to maintain a margin, which is a percentage of the total contract value. This margin acts as collateral and is adjusted based on market volatility. If the market moves unfavourably, the trader may be required to add more funds to maintain the position.
Mark-to-Market (MTM)
Mark-to-market is the daily process of adjusting the margin balance to reflect the current market value of a futures contract. If the contract moves against you, you will need to top up your margin to maintain the position, while favourable movements can increase your margin balance.
Contract Turnover
Contract turnover refers to the total value of all F&O contracts traded within a particular period. This is an essential metric for traders as it indicates market liquidity and helps in planning trade strategies.
Different Traders in F&O Market
Several participants make up the F&O trading market, each with their strategies:
- Hedgers: They aim to protect themselves from price fluctuations by locking in future prices.
- Speculators: These traders profit by predicting future price movements.
- Arbitrageurs: They leverage price differences in markets to earn profits.
Risks and Costs in F&O Trading
One cannot discuss F&O trading without touching on the risks and costs involved. It is essential to understand the complexities, especially when dealing with high-risk stock options trading strategies.
Additional costs such as GST, securities transaction tax (STT), etc., should also be factored into your calculations. Many new traders are surprised by how quickly these fees add up, impacting overall profitability.
Summing it Up
Understanding the landscape of F&O trading can open up significant opportunities for growth and portfolio diversification. From F&O stocks to more complex strategies in futures and options, becoming an educated investor is the key to success. If you are exploring an F&O app or weighing up the benefits of trading stock trading options, the first step is learning and understanding the fundamentals of the market.
HDFC SKY stands out among the various apps available for F&O trading, thanks to its intuitive interface that ensures a seamless and efficient trading experience. This F&O app enables users to diversify their portfolios by offering access to mutual funds, stocks, and IPOs.
With this F&O trading app, demat account opening online is a quick and simple process, thus helping you get started on your investment journey in no time.
