Futures and Options trading is a popular type of trading in the stock market that allows traders as well as investors to leverage their positions or to hedge risks and an opportunity to maximize profits. Futures and Options (F&O) trading can be complex as well as intimidating for t newcomers. This article tries to simplify the basics and to provide a step-by-step guide for starting trading Futures and Options.
What Are Futures and Options?
Futures:
Basically, Futures is a legal binding agreement to buy or sell a particular Asset at a pre-decided price at a specified time in the future. These futures contracts are standardized contracts traded on exchanges.
For Instance: If as per your analysis the price of Silver will increase soon, then you can enter a Futures contract to buy silver at today’s price.
Options:
Basically, options contract gives buyer the right but not the obligation to either buy an option or sell an option of a particular asset at a specific price on or before the expiry of that contract.
For Instance: If as per your analysis the price of crude oil will rise, then you can purchase a call option to benefit by the upside momentum or you can sell put option, without the obligation to buy or sell the stock itself.
Why Trade Futures and Options?
- Leverage: One can trade larger volumes with comparatively lesser investments.
- Hedging: One can protect portfolio against market volatility.
- Flexibility: Options present the right to either buy or sell without obligation.
- Profit Opportunities: It gives opportunity for profit from rising as well as falling markets.
Risks of F&O Trading
Though Futures and Options trading provides ample of opportunities, it also comes with great risks:
- Leverage Risk: It signifies both, profits as well as losses.
- Complexity: For trading in Future and Options one must have proper knowledge of market movements as well as trading strategies.
- Time Sensitivity: Since there is monthly expiry of all option contracts, the value of option contracts decreases over the time.
Step-by-Step Guide to Get Started
Step 1: Understand the Basics
Before starting trading in Futures and Options, accustom yourself with how futures and options work.
- Understand important terms like strike price, premium, expiry date and margin.
- Understand the difference between futures and options.
- Read books, as well as watch educational videos and attend workshops on Futures and Options Trading.
Step 2: Open a Trading Account
One needs the following for trading in Futures and Options:
- A Demat Account: Active Demat account is required for holding securities.
- A Trading Account: It is essential to have trading account as all the trades will be done through trading account only.
Make sure that your broker provides permission to access to the derivatives market and offers smooth and friendly platform with all trading tools.
Step 3: Define Your Trading Goals
Be very clear regarding why you want to start trading in Futures and Options:
- Is hedging of portfolio is the reason?
- Is it only speculation trading to earn more profits?
- Is it only to manage your risks?
Being very clear regarding goals helps in choosing the correct strategies and contracts.
Step 4: Study the Market
For successful Futures and Options Trading, one need to have a deep understanding of market trends
- Proper Analysis of price movements of underlying assets like stocks, indices as well as commodities.
- Proper knowledge of technical indicators like moving averages, RSI, MACD etc.
- Before starting to trading, one should observe the price movements in futures and options as per market news and events.
Step 5: Choose Your First Contract
To minimize risk, beginners should start trading initially with one or two lots
- Futures: Select a stock or index with sufficient liquidity to ensure smooth entry and exit.
- Options: Start options trading with simple and basic strategy like buying a call option or buying a put option.
For instance: If your analysis says that Bank-Nifty Index will rise in few weeks, then you can buy a Bank-Nifty call option at an appropriate strike price.
Step 6: Learn Risk Management
For successful trading in Futures and Options, risk management is the most important factor
- Set Stop Loss Orders: Apply stop loss in your every trade, this helps immensely in minimizing losses.
- Use Position Sizing: Always avoid trading all your capital in single trade.
- Diversify: Always diversify your trading.
Step 7: Track Your Trades
Regularly monitor your trade to assess one’s trading performance.
- Always evaluate whether your trading strategy is in line with market trends.
- Adjust your trading position size based on current market scenarios.
Step 8: Practice with Paper Trading
To get a fair idea regarding Futures and Options trading, practice it with paper trading or simulated accounts before using real capital
- Back test different strategies with paper trading.
- Note down your mistakes and learn from the same.
Step 9: Stay Informed
Always stay updated with latest market news as well as Global events.
- Several key Economic Indicators like GDP, inflation etc.
- Quarterly as well as Annual earnings reports.
- Changes in Government as well as Government policies.
Step 10: Gradually Advance to Complex Strategies
Once you have a fair idea about trading in Futures and Options, understand the most used advanced strategies:
- Straddle: Simultaneously buying a call and put option to maximize profits from market volatility.
- Covered Call: Selling call options of a stock owned by you.
Common Mistakes to Avoid
- Over-Leveraging: Taking trade positions too large compare to your capital.
- Ignoring Expiry Dates: Missed to close contracts before expiry of that instrument can lead to unexpected losses.
- Emotional Trading: Over trading to cover your past losses can lead to more losses.
Conclusion
Though Futures and Options trading is a very lucrative venture if done with proper knowledge and with strict discipline. Understand the basics of Futures and Options before starting with trading. Proper Risk management, stop loss orders, trading experience are the key factors for long term success in Futures and Options trading.
By strictly following this principles, one can confidently start trading career in Futures and Options.
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