A market much bigger than equities is the equity derivatives market in India. Derivatives basically consists of 2 key products in India viz Options and Futures. The difference between future and options is that while future is linear, options are not linear. Derivatives means that they do not have any value of their own but their value is derived from an underlying asset. For example, options and futures on Reliance Industries will be linked to the stock price of Reliance Industries and will derive their value from the same. Options and Futures trading constitutes an important part of the Indian equity markets. Let us understand the differences between Options and Futures and how equity futures and the options market form an integral part of the overall equity market.
So, how do I benefit from options and futures?
Let us look at futures first. Assume that you want to buy 1500 shares of Tata Motors at a price of Rs.400. That will entail an investment of Rs.6 lakhs. Alternatively, you can also buy 1 lot (consisting of 1500 shares) of Tata Motors. The advantage is that when you buy futures, you only pay the margin which (let us say) is around 20% of the full value. That means your profits shall be five-fold if you would have invested in equities. But, the losses could also be five-fold and that is the risk of leveraged trades.
An option is a right without an obligation. So, you can buy a Tata Motors 400 call option at a price of Rs.10. Since the lot size is 1500 shares, your maximum loss will be Rs.15,000 only. On the downside, even if Tata Motors goes to Rs.300, your loss will only be Rs.15,000. On the upside, above Rs.410 your profits will be unlimited.
What is future and options?
A future is a right and an obligation to buy or sell an underlying stock (or other assets) at a predetermined price and deliverable at a predetermined time. Options are a right without an obligation to buy or sell an equity or index. A call option is a right to buy while a put option is a right to sell.