The futures and options (F&O) are derivative instruments that derive their value from the underlying asset. They are used primarily to hedge an investment against losses. Read further to know how they work.
Futures and Options (F&O) are a particular kind of trading instrument falling in the category of derivatives. They have gained prominence in stock markets in recent years. In trading, a derivative is a contract that derives its value from an underlying financial asset. Under F&O trading, the investor doesn’t necessarily have to buy the underlying asset but can gain from its price fluctuations in the market
These financial contracts are signed at predetermined prices to trade a security in the future. This means that the buyer agrees to purchase derivative (s) at a future date at the decided price. As a result of the contract, the parties strive to minimize the risk involved by hedging against price variations. Meanwhile, the changes in the market price ascertain the profits or losses, which can go in either direction if the market conditions are not accurately predicted.
Although both futures & options are known as derivative contracts, there is a significant difference between them.In futures, the buyer has an obligation to buy the underlying stock at the predetermined price when the contract matures, regardless of his ability to earn profit because of the trade.
On the other hand, in the case of options — a trader has a choice to buy or sell the equity any time during the duration of the contract i.e. one has the right but not an obligation to buy or sell the security. There are two types of options: the ‘call’ option where a trader has an option to buy the stock at the predetermined price anytime during the contract and the ‘put’ option where the trader has the option to sell the stock when it reaches a specific price.
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