Trading in Futures and options are much more volatile in comparison to equity trade. These are fast-moving trades where the margin can fluctuate daily and so profit/loss. Unlike equity, which attracts long-term investors, futures and options are meant for traders who are looking for quick returns. If managed in a planned manner, they allow you to protect yourself from a volatile market, while slowly increasing your gains.
Trading futures and options is not rocket science, but it does need a level of understanding before you dive in. It can be a great tool to hedge your bets and save you from market volatility. Alternatively, as a speculator it can be a medium to play the volatility to make outsized returns, but that approach comes with its own substantial risks.
Derivative trading requires you to understand the movement of the market. Even if you trade through a broker, there are some factors that must be kept in mind.
5 Factors To Remember While Trading In Futures and Options (F&O):
- Don’t be fooled by the leverage
Futures and options assets are heavily leveraged with futures usually seeing a harder sell than options. You are more likely to hear about the profit you can make in the future by fixing an advantageous price. What you are less likely to hear is that the margins can work both ways. You may be forced to sell at less than the market price or buy at more than the market price.
In other words, your likelihood to make a profit is theoretically as good as the likelihood to make a loss. While options may seem like the safer option, as discussed above, you are far more likely to defer trade and lose the premium value, hence, making a net loss.
- Staying within your risk margins
Your risk appetite is the amount of risk that you are willing to take in order to meet your objectives. When trading in derivatives, the underlying motivation is to reduce the risk by fixing the price in advance. In practice, a trader will always try and go for a price that will offer healthy gains. But one of the maxims of investments holds true in this case as well, the higher the reward, the higher the risk. In other words, think of the risk you will be willing to take when agreeing to any price.
- Setting up stop-loss and take-profit level
For seasoned traders, one of the oft-used tools to control their trade is setting up stop-loss or take-profit levels. A stop-loss is the maximum amount of loss that can be undertaken while a take-profit is the maximum profit you will settle for. While the latter may seem contrary, a take-profit point allows you to fix a price where the stock can stabilise before falling. These are the twin price points within which a trader operates.
- Margins and market volatility
While it may seem that we are hedging our bets and ensuring healthy margins on a futures and options trade, you must keep in mind that these margins are themselves subject to the movement of the market. In a volatile market, if your trade is making a large notional loss, you will be required to post higher margin quickly, else risk the broker squaring off your trade and losing your existing margin.
- Be aware of the costs
Derivative trading does not require a demat account. It is often seen as a more economical alternative in terms of cost price. But don’t be fooled by the lower brokerage. There are additional costs that include stamp duty, statutory charges, goods and services tax (GST), and securities transaction Tax (STT). But the real cost hike comes from the frequency of trade. Derivative trade is quick with multiple transactions in a short time, which multiplies the cost of your overall trading. Hence, it is always advisable to keep a check on the number of transactions against the gains you are making.
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