Tuesday, 24 April 2018

Future Contracts and Options Terminologies, Types of stock option and its Advantages

Future Contracts:

Currently futures of many stocks, index and commodities are available for trade.

Why can buy Futures?

It is a misapprehension in market that only those who can take more risk in the market must consider trading in futures; others must stay away from it. One fails to understand here that its not just about risk, but lot of factors are involved in it. It is definitely a risky product, as the profit and loss probability is unlimited. One can make unlimited loss in a future, and one can make unlimited profits from it.

In futures one has to trade within a certain time limit, and if they don’t have adequate mark to market and margin money at hand, they end up in compulsory losses. So one has to take positions with all the factors in mind and need to have extra money at hand to pay mark to market and margin as and when required.

Who mustn’t enter the Futures Market?

Those who don’t have adequate margin and market –to-market money at hand must never enter futures market. As such people will mostly end up making the loss, which could be huge. People who can’t take rational decisions and follow the strict rules should not enter into the futures market. One has to strictly follow the stop loss and straggling stop principles to cut losses in time, and also be able to take most of the profits habitat. Those who don’t develop these skills must never think of stock futures.

Warren Buffet has exactly said that” Derivatives Instruments are Financial Weapons of Mass Destruction”. It is the truth because most of the people are unskilled to trade such complex mechanisms, and when they try to trade with inadequate knowledge, they always end up making the huge losses, where not only their capital is battered, but they incur fresh loss, which they have to pay by selling their precious assets. So first become a trained and disciplined trader and only then think of entering futures market. It is also a fact that those who obtain these skills can make a fortune by trading futures.


Options are of two types. They are

  • Call Option
  • Put Option

Call Option:

Call Option is defined as to gives the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date.

Put Option:

Put Option is defined as to gives the buyer the right but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.

  • When one is bullish, they buy a call option
  • When one is bearish, they buy a put option

Options Terminology:

American Option:
An American Option, which can be exercised any time on or before the expiry date.

European Option:

An European Option, which can be exercised only on expiry date.

Strike Price/Exercise Price:

Price at which the option is to be exercised.

Expiry Date:

Date on which the option expires.

Exercise Date:

Date on which the option get exercised by the option holder/buyer.

Option Premium:

The price paid by the option buyer to the option seller for granting the option.
Difference in case of buying options and futures is that in options in the loss is limited and profits can be unlimited. Those who want to take less risk can go for stock options.

Advantages of Stock Options:

  • Highly Leveraged, as minimum capital required is less
  • Pre-known maximum risk for an stock option buyer.
  • Highest returns probable and limited risk for stock option buyer.
  • One can protect his equity portfolio from a decline in the market.

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