SEBI has announced that Futures and Options Trading shall be allowed till midnight from 1st of October, 2018. Let’s take a look at what trading in Futures and Options could really mean for retail investors and debunk the myth that F & O trading is too complicated for everyone.
A lot of investors stay away from futures and options because they think they’re complicated, but this simply isn’t true. With the right amount of discipline and commitment, ANYONE CAN LEARN HOW TO TRADE FUTURES. At its very core, a futures contract is nothing more than a binding agreement between a buyer and a seller to either buy or sell the asset or financial instrument involved at a predetermined price and time. When compared to stocks futures contracts offer a number of distinct advantages.
- Higher Leverage
The single biggest advantage of trading futures and options is the leverage that comes with it. This makes trading in F & O very attractive for small pocket traders. By taking position in options, one can reduce their cost significantly. An investor doesn’t have to put up the full amount – but usually just a small fraction of the total amount (typically 10 percent). In other words, an investor can get his hands involved in a Rs. 100,000 contract with just Rs. 10,000 of his own money. This is what makes trading futures so exciting.
- Fixed Up Front Costs
For the most part, the margin requirements for a major futures commodity are pretty constant and well known. They don’t fluctuate very much – even over a number of years – which is contrary to option premiums that can vary rather significantly as the market shifts. This stability means traders know what to expect and are aware of how much is required to be put up as the initial margin.
- High Liquidity
You don’t have to worry about tying up your money long term. Futures contracts are traded in very significant volumes every day, which makes them highly liquid investments. For someone who has other holdings on the opposite end of the spectrum, this makes futures extremely attractive.
- Limits Risk
Another benefit of options buying is that the risk is limited to the investment you make. Suppose, in context to the above example, you buy shares of ABC Ltd. and on the next day, the company comes up with the news of closing one of its subsidiaries and aftermath the stock opens 15% below your entry price. Now, the stock price falls to Rs. 110.50, while the 130 call becomes zero. In case of stock, you would incur a loss of Rs. 2,34,000; while in options, you would lose Rs. 60,000 – the entire investment amount, which is far less than the one incurred in stock trading.
- Futures are great for trading certain investments
Futures are a great way to trade specific investments such as commodities, currencies and indexes. Their standardized features and very high levels of leverage make them particularly useful for the risk-tolerant retail investor. The high leverage allows those investors to participate in markets to which they might not have had access otherwise.
- Better Tax Rate
Did you know that you can actually get a major tax break when trading futures, versus stocks and securities that command short-term capital gains rates?
- Ease of Filing
Another tax-related benefit of trading futures is that you don’t usually have to provide a detailed list of each trade you made throughout the year – as is the case with securities traders. This saves you a ton of time and makes it a lot easier to manage things during tax season. However, you do still have to keep very detailed files and records. If you’re ever audited, you’ll have to provide enough details to support your numbers.
- Higher potential returns
By trading in options, one will experience higher percentage returns compared to stocks. Lets assume, the delta of ABC Ltd. is 0.80, which suggests that options price will rise by 80% of stock price. If stock moves up to Rs. 13, you will earn 10% return. While your option position will gain Rs. 10.40 on the investment of Rs. 5. Here, the return on investment is nearly 208%, which is much better than the return on stock.
- Works in different market scenarios
One of the key advantages of options trading is alter strategies as per different market conditions. There are various strategies for all kind of markets, whether bullish, bearish or sideways – Long call, Bull call spread, Long Put, Bear put spread, long straddle, short straddle, etc. One can switch his strategies as per market condition.
Every individual trading in stock market is exposed to a certain risk. In the event of any adverse market movements, hedging simply protects your trading positions from incurring loss. Suppose, you picked a stock of ABC Ltd. for Rs. 100 six months back and now it is trading at Rs. 125; here, you are earning a return of 25% on your investment. Now due to result season, you realize that the markets may soon enter a turbulent phase, which may also result in losing the money you earned during this time frame. In such scenario, you can hedge you position by simply buying At-the-Money put option for same quantity, which will limit your downside during adverse market condition.
Learn more about Futures & Options at BSEvarsity.