Why do we need F&O contracts?
What is difference between Futures and Options?
Why do we call them contracts with predefined or predetermined fixed charges even if we buy and sell the futures at whatever their current market value is there?
List of doubts goes on and on but i assure you, after reading this article or watching video on our youtube channel, you will be left with o doubt on this topic. If this is your your first article read on Futures trading, than congratulations, you have saved a lot of time of your's.If you want to watch the video , it is embedded on this page only and if you want to subscribe our youtube channel, you can directly go to our channel by clicking the icon provided at the top of this page.
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What are derivativesDerivative is a financial instrument which derives it's value from an underlying asset.So , what do mean by underlying asset here?
See, you must be knowing about stocks ,it have it's own value, but the value of derivatives is dependent on the value of stocks.If the calue of stocks increase, value of derivatives will also increase and if the value of stocks will decrease, value of derivatives will also decrease.
If understanding with an example, you must have paper money, why do a 2000 rupee have that value even if it is only a paper? This is because of the signature of RBI Governor on it. The signature certifies that this 2000 rupee note now hold the value of 2000 rupee and nobody can deny it. Now, the paper don't have it's own value like gold or silver coins but it derives that value from the Governor signature. Therefore , the currency note is a derivative and the signature is underlying asset which provide the value to currency note.
Derivatives are of 4 types:
So, here in this article, we are going to discuss about What are Future contracts in stock market trading?
What are Futures in Stock MarketFuture contracts in stock Market are obligatory contracts of buying and selling of stocks with an expiry date. Now this single line definition have some words like expiry and oblgatory which must have certainly got your attention . This is just a theoretical definition and a single definition can't make us understand about whole topic. So let us discuss it in detail.
When you buy Futures ,it doesn't mean that you are buying any stocks at that time, but it means that you making a commitment to buy or sell the stocks in near future and what is so special about this is that you decide the price at which you would buy the stocks after few months.Now, when you set the entry point beforehand, you will have to abide by it and buy or sell those stocks at that fixed price and at fixed date which is known as the expiry date.
Futures are derivatives as we discussed above which derive their value from stocks. But how do Futures and options derive their value from stocks ? Let’s discuss.
To make it easy for you to understand, let’s discuss it with the help of an example. Suppose ,there is a locker somewhere in himalyans having 1crore rupee in it and that locker can be opened only with one key. Now if you get that key, it means that your are the only one who can get those 1 crore and thus, it can be said that having the key means having 1 crore rupees. This makes the value of that key to be 1 crore . Now ,due to some reasons ,if can’t collect the money from locker, this does not mean that you have lost the whole money. If you have the key, nobody will be able to open that treasure. Now, if you want to sell that key for 80lakh, most probably, you will find the buyer because with this key, he can get 1 crore rupees with an investment of 80 lakhs.
Once the locker have been opened by someone and he or she have taken the whole money, now the key will loose it’s purpose and now, it’s value is same as any other normal key and nobody would agree to buy it. Let’s take one more example,
one day ,someone wealthy and very religious person announces that he will donate 1 lakh rupee to each person whosoever will be having a DIYA( lightening lamp which people use in temples to worship) of a particular pattern printed on it. Now, I know this can make the person bankrupt but we are only discussing a hypothetical case. Now , diya with that pattern have become worth 1 lakh. If you would try to sell that diya to anybody for around 1 lakh, you can do it because that diya have got it’s value from the announcement of the person. Once the person have distributed the money, now , nobody will buy that diya for 1 lakh ( we are not considering the auction scenario here).
So, Futures and options also work this way.
Futures are contracts which acts like the key to a large number of stocks. So, when you buy futures, you you are now having certainity that I will get these stocks at a given price after some time. Now, the future contracts have expiry date. What this expiry date means is that when the contract expires, you will get the stocks in your demat account which are mentioned in the futures contract. After you get the delivery of stocks in your demat account, now those futures don’t have any value as you don’t need them now.
Now, as we saw in the case of key of treasure or that specific pattern DIYA, they had value till the exchange had took place and if they wanted to sell those diya’s or key, they could do this easily. Similarly, futures also hold some value and thus , the future contract holder can sell that contract to someone else at the current market value of that contract and you will get your money. Many investors buy futures for this purpose only to sell it before it’s expiry .So, this can be done by buying and selling traditional trades also, why do these traders buy ( if you don’t know how this buying and selling of futures takes place, read this article to the end and you will be having no doubt related to this article after reading it because this article contains the complete explanation of futures and options contract in stock market). Every doubt will be cleared in the trading procedure of futures which is our next section of this article.
Learning with Real Trading example of Futures at Zerodha PlatformFirst of all want to make clear that this not any type of promotion to choose zerodha. Most of people in india use either zerodha or upstox for trading stocks. Even an article had also been published on Zerodha vs Upstox: whichone is better , so you may visit and choose the best one out.So, i chose Zerodha due to it's familarity with most of the traders.
Disclaimer :This article gives example based on the data of 8th of August 2020,so whenever you read today, understand it to be the ate mentioned and current month as August.
When you log into your trading software, Zerrodha Kite here, search for the futures of the company you want to invest in.For example, you have great faith in ONGC to invest in, so search for ONGC FUT there. Three results will be shown on your screen, actually these are three types of futures you can get i.e.
Near month future,
Next month future and
Far month future
Now, the current month is August, so the near month in this case is August ,next month is september and the far month is october.
Here you get the choice to buy any of thesse three future contracts.As of today, all three are being available for around ₹78-79 , now if you think that at the end of september month, chances are greater for it's value to be much more tha ₹80, than you can definitely buy the SEPT FUT of ONGC.What will this do is , if the ONGC stock hits ₹95 by the end of september, you will get the delivery of these stocks at the cost of ₹79(at the price mentioned in the contract). But if your prediction goes wrong and it falls to ₹50, then also , you will get the delivery of these stocks to your demat account at the price of ₹ 79 if you do not exit this trade before the expiry date( will discuss it later in the section of settlement and exiting of future contracts).
Like that of stocks, value of Futures also keeps fluctuating which depends on the price movement of stocks as futures are derivatives. If the value of stocks go up, value of futures increase and if the value of stocks decrease, value of futures also decrease.
The price at which you enter the trade, it is the price at which you will buy the stocks after the futures expire.
Now as we have decided to buy SEPT FUT at ₹80,great. Here I want to tell you some points which you will require to trade in futures which can be attributed as the features of Futures and Options too.
Buying in LotsWhen you trade in F&O , you can not trade simply in 1,2 or 3 stocks. You have to buy the lots of these stocks.Now,what do lots mean in Futures and Options? Lots are the group of shares of the same company. Each company have a fixed lot size (minimum number of stocks that can be traded in future ).
As in our case, we want to buy september futures of ONGC, so the lot size in this case is 7700.So the minimum number of stocks in which we can invest is 7700 here.
Lot size may vary from company to company ,which is decided by the stock exchange time to time depending on the price of the shares of a given company. If you want to check out the present lot sizes, you can do so by cicking here.
If you want to buy more shares than 1 lot, than also, you will have to buy in the multiples of lot size. Like in the case of ONGC, we can not buy 7701 or 7800 share, we will have to buy 1 lot, 2 lot etc.
Trading with Margin or Leverage in F&OLeverage is kind of a loan which your broker provides you to trade without any rate of interest.In normal equity trading, you can not trade on Leverage or margin, though you get it for intraday equity trades.
The future contract can be bought on leverage and the amount of leverage provided varies from broker to broker. Many traders trade in futures only due to this reason because they don't need to invest the whole amount and then they sell it before it's expiry
Futures can be held in Short as well as Long TradesIf you are not familiar with these terms, let me explain them to you:
Long Position : Trading of stocks in which you buy the stocks first and sell them later. Short Position : Trading opsition in which you sell the stocks first and buy them later. This type of trading is preffered when a falldown in the market is expected, than you sell the stocks at higher price first and then buy them back at lower price.
In traditional equity trading, you can only go for long position in intraday trading, but not in the delivery trades. If you want to hold a short position more than one day , you can do this by entering the F&O orders.
Now this is all about entering the Future contracts. Let us discuss, how to settle these future trades and exit them?
How to exit and settle Future contracts?Here are two terms in this topic which we have to discuss.You need to choose any one of them once you enter into Future trade:
1) Settlement of the Futures contract
2) Exiting the contract
Let us discuss them one by one
1) Settlement of the Futures contractSettlement of the contract means getting the delivery of stocks in your demat account after expiry of your future contracts.This is the reason why these contracts are called obligatory.Obligatory means that you will have to complete the trade once you have decided to enter it.
The expiry of any contract is fixed i.e. last friday of the respective month. If there is any public holiday on last thursday of the month, than it expires on the last wednesday of the month.