Futures & Options

The explosive growth of Futures & Options (F&O) trading in India has triggered concern among top financial authorities over the high number of retail investors entering the derivatives market without proper knowledge, despite 90% of them incurring losses, according to SEBI’s internal data.

What Are Derivatives?

• A derivative is a financial contract whose value is based on (or "derived" from) the price of something else — called the underlying asset.
• These underlying assets could be:
  • Stocks (like Reliance shares)
  • Stock market indices (like Nifty 50)
  • Commodities (like gold, silver, crude oil)
  • Currencies
  • Interest rates
• Example: If you have a contract that depends on the future price of crude oil, the price of that contract will move up or down depending on how crude oil prices move in the market.
• Derivatives do not involve actual ownership of the underlying asset. They are more like bets on where the price of an asset will go. This makes them tools for hedging risk, speculation, or leveraged trading.
• Among the most commonly traded derivatives are Futures and Options.
  • Futures: It is a contract obligating the buyer to purchase (and the seller to sell) an asset at a predetermined price on a future date.
    • Both parties are obligated to execute the contract at expiry unless closed earlier.
    • Types: One type – long (buy) or short (sell) futures contracts.
    • It requires a margin deposit (a small % of the contract value).
    • It is primarily used for hedging by producers/consumers or speculating by traders.
    • Profit & Loss: Gains/losses are unlimited and realized daily (marked to market).
    • Example: A trader agrees to buy crude oil at USD 80/barrel in 2 months. If prices rise to USD 90, the trader gains USD 10/barrel.
  • Options: It is a contract giving the buyer the right (but not obligation) to buy or sell an asset at a specific price before or at expiry.
    • Only the seller (writer) is obligated; the buyer can choose whether or not to exercise the option.
    • Types: Two types – Call options (right to buy) and Put options (right to sell).
    • Buyer pays a premium (non-refundable cost of the option).
    • It is used for hedging, speculation, or income generation (by writing options).
    • Profit & Loss: Buyers have limited risk (premium paid) and unlimited gain (for calls). Sellers (writers) take more risk depending on the option type.
    • Example: A trader buys a call option to buy crude at USD 80. If prices rise to USD 90, the trader can exercise and gain USD 10 – premium paid.