Futures and options are stock derivatives that are traded in the share market and are a type of contract between two parties for trading a stock or index at a specific price or level at a future date. By specifying the price of the trade, these twin derivatives safeguard the investor against future fluctuations in the stock market. However, the actual futures and options trade is often far more complex and fast-moving.
While many people deal in futures and options through a trader, it is always advisable to understand their functioning before you invest in them.
Types of Futures and Options
Futures are fundamentally uniform with the same set of rules for buyers and sellers.
Options can be of two types: call option and put option.
A call option allows you to buy the underlying asset at an agreed-upon price at a specific date.
A call option contract gives the buyer of the contract the right to purchase the underlying asset at a predetermined price on a predetermined day. In exchange for receiving this right, the buyer of the call option contract pays a certain sum of money known as the premium to the seller of the call option contract.
Call options – an example
If you happen to visit the call options section of the National Stock Exchange or your trading portal, you will likely see something like this – INFY SEP 1600 CE. This is a typical example of a call option contract of Infosys Limited.
Now, when you purchase this call option, you basically get the right to purchase a set number of shares of Infosys (which in this case is 600 shares) at Rs. 1,600 per share on a predetermined date in the month of September. Let’s say that this options contract is priced at Rs. 200 per share, which is the premium that you would have to pay to the seller to purchase this contract. So, to obtain this right, you will have to pay around Rs. 1,20,000 (Rs. 200 x 600) to the seller.
A put option allows you to sell the asset at a specified price on a specific date.
A put option contract is the inverse of a call option contract. It gives the buyer of the contract, the right to sell the underlying asset at a pre-agreed upon price on a predetermined day. And as with call options, the buyer will have to pay a premium to the seller for receiving this right.
Put options – an example
Similarly, if you visit the put options section, you will see something like this – TCS NOV 2500 PE. This is a typical example of a put options contract of TCS Limited.
With the purchase of this contract, you essentially get the right to sell a set number of shares (which in this case is 300 shares) of TCS for Rs. 2,500 per share on a predetermined date in the month of November. Now, assume that the contract is priced at Rs. 120 per share. To purchase this contract, you will have to pay the seller Rs. 36,000 (Rs. 120 x 300) as premium. This will give you the right to sell 300 shares of TCS at Rs. 2,500 at a predetermined date in November.
In both cases, the trade is always optional. You can choose not to utilize your call or put option if the prices do not suit you.