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 :)