How to Use Futures & Options for Wealth Creation
nvestors extensively use futures and options as instruments for portfolio management, hedging, and speculative trading in the world of financial markets.
Investors extensively use futures and options as instruments for portfolio management, hedging, and speculative trading in the world of financial markets. Understanding F&O meaning, what options are, and how to use Futures & Options for wealth creation opens doors for them to participate in numerous opportunities in the market.
F&O Meaning: What Are Futures and Options?
F&O stands for Futures and Options, which are types of derivative contracts. A derivative's value is based on underlying assets, which could be stocks, shares, indices, commodities, or currencies. They do not confer ownership of the asset but rather confer rights or obligations based on the price movement of that asset.
Futures bind a buyer and a seller to a particular price of the asset on a future date. The buyer of an asset for a future date will act under an option.
An option is a kind of financial contract that bestows upon the buyer the right (but not the obligation) to buy (call options) or sell (put options) an underlying asset at a price agreed upon beforehand (strike price) within a specified period. The seller or writer of the option must fulfill the contract if the buyer exercises the option.
Investors can distinguish between the two main types of options:
Call Options: Call options give the buyer the right to buy an asset at a fixed price. They make the investment with the view that this asset's price is likely to go up.
Put Options: Put options give the buyer the right to sell an asset at a certain price. Investors use these in situations where they believe the securities price is likely to fall.
Using Futures & Options for Wealth Creation
1. Hedging Portfolio Risk
An F&O contract serves as an instrument to hedge against the market's risk factor. For instance, if an investor has a long share position in a company but fears a decline in the price in the short run, they can buy a put option. In that case, if the stock price goes down, the put option's value appreciates, thus covering their portfolio losses to some extent.
2. Generating Income through Options Writing
Investors with a neutral to moderately bullish outlook may sell (write) call options on stocks they hold. This is called a covered call strategy. By doing so, they earn a premium that counts as cash income. In other words, if the share price does not cross the strike price, the option will expire worthless, and they will retain the premium.
3. Speculation based on Market Views
Traders with short-term market views benefit from F&O by placing trades in the market. Catching a position with F&O contracts is, of course, simpler said than done since it requires a lower amount of capital compared to purchasing the underlying asset. However, this leverage can also increase the risk.
4. Spreads and Combinations for Controlled Risk
Advanced option strategies manage risk using a mixture of various options. Each has a specific purpose based on market outlook, volatility, and time horizon.
5. Long-Term Positioning through Futures
Investors can also use futures for medium- and long-term views. If they believe there's a strong likelihood for an increase, they will take a long futures position. Whereas futures contracts are time-bound and need to be rolled over, they present a way for investors to express directional views using leverage.
Risks Associated with F&O Trading
However, futures vary significantly from options in that they have symmetrical risk. Neither profits nor losses are asymmetric; they are linear, and mark-to-market may require daily settlements that necessitate maintaining adequate margins.
Where there's potential for wealth creation through F&Os, investors must also understand that they come with associated risks. Gains and losses can be magnified due to leverage. Sudden market movements, volatility changes, or variations in interest rates can alter the pricing landscape for derivatives.
Margin requirements with daily settlements for futures necessitate planning for capital. To avoid outright disaster, options sellers must manage their risk with stop losses and position sizing.
Conclusion
The knowledge about F&O meanings, what options are, and how it suits to use futures & options for wealth creation enables investors to relate to market movements, address risks, and create trades based on their views. With disciplined execution and risk controls, investors can leverage F&O as meaningful instruments in structured investment decision-making.
