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Wednesday, 1 November 2017

What is "Future and Options" in Stock Market

Many of the people who get into Equity market aka Stock Market directly only deal with one part of it called “Cash Market”, a market where one can buy and sell shares from quantity 1 to many depending on money one has. There is another part of Equity market called “Future and Options” abbreviated as F&O.

What is F&O :

F&O is Contract based trading instrument which has validity from 7 days to 90 days depending on whether it is for INDEX like NIFTY / BANK NIFTY or individual stocks. In this there is no transaction of shares until the last day of contract and there is just agreement made between Buyers and Seller to abide by contract price and date. The Price in Cash market and Price and various data points in F&O market affect each other.

Future:

Future instrument is a contract between buyer and seller about Future price of a stock or Index. In Indian market Future Contracts are of one month expiring on last Thursday of every month and the new contract starting just a day after that. One can buy individual contract of next 3 months as only 3 Contracts can be active at one time for any stock or Index. Basic component of Contract are Stock name, Future agreed Price and expiry date. So INFY 26 OCT17 FUT means Future contract of Infosys for October month expiring on 26th October 2017.

If one buys Future contract of INFY for October month, buyer is agreeing to buy INFY at price mentioned in future market, at max by last day of contract expiry which is 26th October. Suppose Current Market price of INFY is 900, and October’s Future Price is 920 (because market sentiment is positive), so buyer is agreeing to buy INFY at 920 Rs maximum by 26th October, no matter whether stock price goes down or up.  If stock prices goes to 950 Rs in that month, buyer will make profit because buyer has right to buy same stock at 920 Rs as per contract. If stock price goes down to 880, buyer will lose money because as per the agreement buyer promised to buy INFY at 920 Rs. and vice versa the contract seller will make profit and loss. There can be one more case when INFY stays around 900-905 Rs for whole month and closes at 900 on last day, in this case also buyer will lose money because buyer needs to buy INFY at 920 Rs whereas the market price is 900 Rs and hence contract seller will make profit. 

Now to summarize profit and loss cases for Futures:

Buyer will make money only when stock price moves up from price of future agreement in the Contract month

Seller will make money when stock prices goes down in the Contract Month

Seller will make money when stock prices stays same in the Contract Month

Seller will make money even if stock price goes up by any percentage but after contract expiry date.

As one can see that timing also is one big factor in Future market unlike in Cash market and Buyer and Seller need to be precise enough to make full use of this instrument of stock market. Unlike in Cash market, these Contracts are done in lots and one lot contains many shares, so to be able to use these contracts one needs to have enough capital and margin in their account. The Advantage of it is that brokerage firms let their clients use Margin money to buy or sell Future Contracts and no need to have full money in your account. To give an idea of this, to buy 500 Shares of INFY in Cash Market one needs to have 4,50,000 Rs (500 x 900) in account but to buy same in Future one needs 10% to 50% of total money in account depending on Brokers they are taking service from.

As Options are too big to explain in this post and has two part as “Call” and “Put”, I will be posting it soon as new post :)