Understanding Futures And Options

Understanding Futures And Options

Nifty Financial Services, heavier weight than Bank Nifty, will now be traded in the Derivatives segment. But what are Derivatives? What are Futures and Options? Let’s clear our basics before we delve deeper into the new financial product – Nifty Financial Services Index F&O.

Crux of the Matter

What Are Derivatives?
A derivative is a financial product whose value is derived from the value of the underlying asset, which can be equity, currency, commodity, etc. There are mainly three types of derivatives: Forwards, Futures, Options.

For instance, if there is a financial product called Gold Futures, its value is dependent on the current and estimated supply and demand of Gold, and of course the price of Gold.

Derivative Market And Derivative Contract
The derivative market is a leveraged market. Meaning, an investor wanting to invest in Gold Futures worth ₹1,000 will have to pay only a fraction of the total value of the contract as a margin to the broker.

A derivative contract is available for – current month, next month, and far month. A person can trade in three expiry contracts, meaning, they can hold onto their position for maximum 3 months, after which the contract expires.

What Are Futures?
A Futures Contract is an agreement between 2 parties to buy or sell an asset at a certain time in future at certain price. In India, there are weekly expiries of contract as well as monthly expiries on last Thursday of the month.

Derivative securities have a fixed lot size of underlying assets. For example, the current lot size for Nifty Futures is 75, meaning if you buy one Nifty Futures, it will constitute 75 contracts as a part of the lot.

What Are Options?
An option is a contract which gives a right but not an obligation to buy or sell an asset at a specified date at a specified price.

While a buyer of an option pays the premium and buys the right to exercise his option, the writer (seller) of an option is the one who receives the option premium and therefore is obliged to sell/buy the asset if the buyer exercises it on the writer.

What Is Call Option?
A call option gives the buyer of the contract the ‘right to buy’ a specified quantity of the underlying asset at a strike price on or before the expiry date. The seller, however, has the obligation to sell the underlying asset if the buyer decides to exercise the option.

For instance, the current price of SBI is ₹280 and X buys a Call Option and is entering into a contract to buy 1 share of SBI at the price of ₹300 at the end of the month. X buys the option and pays a premium of ₹5 to Y, who writes (sells) the Option and receives ₹5 premium.

What Is Put Option?
A Put Option gives the buyer, the ‘right to sell’ a specified quantity of the underlying asset at a strike price on or before the expiry date. The seller, however, has the obligation to buy the underlying asset if the buyer decides to exercise his option to sell.

For instance, the current price of SBI is ₹280 and X buys a Put Option and is entering into a contract to sell 1 share of SBI at the price of ₹260 at the end of the month. X buys the option and pays premium of ₹5 to Y, who writes (sells) the Option and receives ₹5 premium.

Now that your basics of Futures & Options are clear, you can head to understanding the to-be-launched Nifty Financial Services Index Futures and Options here.

Summachar brings you this story in collaboration with Finmedium that can be found on Instagram at @finmedium and on the web here.

Curiopedia
  • In finance, being short in an asset means investing in such a way that the investor will profit if the value of the asset falls. This is the opposite of a more conventional “long” position, where the investor will profit if the value of the asset rises.
  • A corporate promoter is a firm or person who does the preliminary work incidental to the formation of a company, including its promotion, incorporation, and flotation, and solicits people to invest money in the company, usually when it is being formed. An investment banker, an underwriter, or a stock promoter may, wholly or in part, perform the role of a promoter.
  • A fiduciary is a person who holds a legal or ethical relationship of trust with one or more other parties (person or group of persons). Typically, a fiduciary prudently takes care of money or other assets for another person.

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