What is F&O?

National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) offer investors with options in futures and options on stocks and indices. A futures contract enables investors to buy or sale of a stock at a fixed price for delivery on a later date. The call option available on a stock facilitates the investor to buy the common stock (underlier) for a fixed price at a later date, on the other hand a put option enables you to sell the common stock. Typically, in an F & O segment only the difference in buy or sell price is exchanged between buyers or sellers during a square of (purchase or sale of stocks and the reversal of the same for potential profit).

  • Futures contracthave fixed conditions such as price, quantity and time.
  • The owner of the contract must either buy or sell in the future.
  • The maximum duration of a futures contractis 3 months trading cycle.
  • At any point of time there will be 3 contracts available for investors for trading.
  • Every futures contract expires on the last Thursday of the expiry month.
  • Future contractstend to move faster as compared to options as options as options move based on futures contracts.

An option (O) is as a contract between two parties where the buyer receives a privilege for which he pays a fee (premium) and the seller receives an obligation for which he receives a fee. When an option transaction (buying or selling) is taking place, the premium is set via negotiation. An individual who is buying the option is called long while an individual who is selling the option is said to be short in the option.

  • Investors in optionscontracts do not have an obligation to buy or sell the underlying asset at the stated date and price. With options there is an advantage of not losing more than the traders initial investment.
  • The maximum duration of an optioncontract is 3 months trading cycle.
  • At any point of time there will be 3 contractsavailable for investors for trading.
  • Every option contract expires on the last Thursday of the expiry month.
  • There is lower risk associated with options (O)as compared to futures contracts (F), in futures contracts one unfavorable outcome can adversely affect your position.

Example

If we consider company A (whose stock is listed under F&O) is releasing their results on Tuesday. Let us consider that a buyer expects the share price to increase to Rs. 100 from Rs. 90, and thereby purchases the futures contract on A at Rs. 90. When the company A declares the results on Tuesday, the stock having risen to Rs. 100, the buyer will make Rs. 10 per share. Typically the he has not put the entire amount of the contract but a portion of it, ie. 12%-15% for trade. Let us consider 100 shares in lot A and buyer puts up 12% of 9000 ie. 1080. If the price increases by Rs. 10 per share he will make Rs. 1000 but if the price falls to Rs. 80, the buyer will make a considerable loss.

Risk of Invariable Losses

Many a times inexperienced investors may try to avoid or reduce their losses by applying call or put options in a day or two prior to the results. The misjudgement in this case is that sellers or writers try to charge large premiums for selling such investors call or put closer to the result. That is, one may end up paying close to twice or thrice the normal price due to high amount of unpredictability, which is one of the factors influencing an options price (O). Ultimately upon the declaration of results, the volatility is drastically reduced and that leads to a drop in the option price. This type of trade has the potential to cost the investor heavy loses. Options (O) are also considered to be affected by time, ie. time reduces the price and in order to reap profits the investor must have made a higher move up for call or down for a put.

Conclusion

Interested investors must try to research by reading more on different F & O’s, discussing their options with experts, and monitoring the inflection and deflection of prices under different situations. One of the mantras that an investor must keep in mind while trading is ‘buy on fear, sell on greed’ and keeping a calm mind can benefit him or her from avoiding reckless decisions.