Future and option trading meaning


As with any of the previous modules in Varsity, we will again make the same old assumption that you are new to options and therefore know nothing about options. For this reason we will start from scratch and slowly ramp up as we proceed. Let us start with running through some basic background information.

The options market makes up for a significant part of the derivative market, particularly in India. Internationally, the option market has been around for a while now, here is a quick background on the same —. Clearly the international markets have evolved a great deal since the OTC days. However in India from the time of inception, the options market was facilitated by the exchanges.

The badla system no longer exists, it has become obsolete. Here is a quick recap of the history of the Indian derivative markets —. Though the options market has been around sincethe real liquidity in the Indian index options was seen only in !

I remember trading options around that time, the spreads were high and getting fills was a big deal. However inthe Ambani brothers formally split up and their respective companies were listed as separate entities, thereby unlocking the value to the shareholders. In my opinion this particular corporate event triggered vibrancy in the Indian future and option trading meaning, creating some serious liquidity.

However if you were future and option trading meaning compare the liquidity in Indian stock options with the international markets, we still have a long way to catch up. There are two types of options — The Call option and the Put option. You can be a buyer or seller of these options. In fact the best way to understand the call option is to first deal with a tangible real world example, once we understand this example we will extrapolate the same to stock markets.

Consider this situation; there are two good friends, Ajay and Venu. Ajay is actively evaluating an opportunity to buy 1 acre of land that Venu owns. The land is valued at Rs. Ajay has been informed that in the next 6 months, a new highway project is likely to be sanctioned near the land that Venu owns. If the highway indeed comes up, the valuation of the land is bound to increase and therefore Ajay would benefit from the investment he would make today.

So what should Ajay do? Clearly this situation has put Ajay in a dilemma as he is uncertain whether to buy the land from Venu or not. While Ajay is muddled in this thought, Venu is quite clear about selling the land if Future and option trading meaning is willing to buy. Ajay wants to play it safe, he thinks through the whole situation and finally proposes a special structured arrangement to Venu, which Ajay believes is a future and option trading meaning for both of them, the details of the arrangement is as follows —.

So what do you think about this special agreement? Who do you think is smarter here — Is it Ajay for proposing such a tricky agreement or Venu for accepting such an agreement? Well, the answer to these questions is not easy to answer, unless you future and option trading meaning the details of the agreement thoroughly.

I would suggest you read through the example carefully it also forms the basis to understand options — Ajay has plotted an extremely clever deal here! In fact this deal has many faces to it. Now, after initiating this agreement both Ajay and Venu have to wait for the next 6 months to figure out what would actually happen. However irrespective of what happens to the highway, there are only three possible outcomes —. Remember as per the agreement, Ajay has the right to call off the deal at the end of 6 months.

Now, with the increase in the land price, do you think Ajay will call off the deal? This means Ajay now enjoys the right to buy a piece of land at Rs. Clearly Ajay is making a steal deal here. Venu is obligated to sell him the land at a lesser value, simply future and option trading meaning he had accepted Rs.

Another way to look at this is — For an initial cash commitment of Rs. Venu even though very clearly knows that the value of the land is much higher in the open market, is forced to sell it at a much lower price to Ajay. The profit that Ajay makes Rs. It turns out that the highway project was just a rumor, and nothing really is expected to come out of the whole thing.

People are disappointed and hence there is a sudden future and option trading meaning to sell out the land. As a result, the price of the land goes down to Rs. So what do future and option trading meaning think Ajay will do now?

Clearly it does not make sense to buy the land, hence he would walk away from the deal. Here is the math that explains why it does not make sense to future and option trading meaning the land —. Remember the sale price is fixed at Rs. Hence if Ajay has to buy the land he has to shell out Rs. Which future and option trading meaning he is in effect paying Rs. Clearly this would not make sense to Ajay, since he has the right to call of the deal, he would simply walk away from it and would future and option trading meaning buy the land.

However do note, as per the agreement Ajay has to let go of Rs. For whatever reasons after 6 months the price stays at Rs. What do you think Ajay will do? Well, he will obviously walk away from the deal and would not buy the land.

Why you may ask, well here is the math —. Clearly it does not make sense to buy a piece of land at Rs. Do note, since Ajay has already committed 1lk, he could still buy the land, but future and option trading meaning up paying Rs 1lk extra in this process.

For this reason Ajay will call off the deal and in the process let go of the agreement fee of Rs. I hope you have understood this transaction clearly, and if you have then it is good news as through the example you already know how the call options work!

But let future and option trading meaning not hurry to extrapolate this to the stock markets; we will spend some more time with the Ajay-Venu transaction. I would suggest you be absolutely thorough with this example. If not, please go through it again to understand the dynamics involved. Also, please remember this example, as we will revisit the same on a few occasions in the subsequent chapters.

Do note, I will deliberately skip the nitty-gritty of an option trade future and option trading meaning this stage. The idea is to understand the bare bone structure of the call option contract. Assume a stock is trading at Rs.

You are given a right today to buy the same one month later, at say Rs. Obviously you would, as this means to say that after 1 month even if the share is trading at 85, you can still get to buy it at Rs.

In order to get this right you are required to pay a small amount today, say Rs. If the share price moves above Rs. If the share price stays at or below Rs. All you lose is Rs. After you get into this agreement, there are only three possibilities that can occur. Case 1 — If the stock price goes up, then it would make sense in exercising your right and buy the stock at Rs.

Case 2 — If the stock price goes down to say Rs. Case 3 — Likewise if the stock stays flat at Rs. This is simple right? If you have understood this, you have essentially understood the future and option trading meaning logic of a call option. What remains unexplained is the finer points, all of which we will learn soon. At this stage what you really need to understand is this — For reasons we have discussed so far whenever you expect the price of a stock or any asset for that matter to increase, it always makes sense to buy a call option!

Now that we are through with the various concepts, let us understand options and their associated terms. Hi Sir, Options is like greek and latin to me. Thanks for the analogies. No, all derivative contracts are routed via the exchanges. You cannot enter into an OTC future and option trading meaning, even future and option trading meaning you do, it would not be regulated hence quite dangerous.

What benefit would Ajay get by calling off the deal before the expiry of 6 months? He will instead wait for the whole 6 months for any chance of the highway project. My first question Karthik is this: The dropdown value on the NSE website does not contain all months expiries — after 18th May we have 25th June followed by 24th Sept and then 31st Dec What happened to the other months?

For to only June and Dec contracts are available. Future and option trading meaning happened to the remaining? Saurabh, glad you noticed it! For all stocks options the expiry is very similar to futures.

Hence we have current month, mid month, and far month contracts. However for Nifty there are several different expiry options. Leaps are good if you have a super long term view on markets.

However the problem with leaps in India is that they are not liquid, there are hardly any trading activity here.

How are Stock Futures different from Stock Options? In stock options, the option buyer has the right and not the obligation, to buy or sell the underlying share. Risk-return profile is symmetric in case of single stock futures whereas in case of stock options payoff is asymmetric. Also, the price of stock futures is affected mainly by the prices of the underlying stock whereas in case of stock options, volatility of the underlying stock affect the price along with the prices of the underlying stock.

What are Stock Futures? How are Stock Futures priced? What are the opportunities offered by Stock Futures? How are Stock Futures settled? Can I square future and option trading meaning my position? When am I required to pay initial margin to my broker? Do I have to pay mark-to-market margin? What are the profits and losses in case of a Stock Futures position? What is the market lot for Stock Futures? Why are the market lots different for different stocks? What are the different contract months available for trading?

What is spread trading on BSE? As an investor, how do I start trading in Stock Futures? What securities can I submit to the broker as future and option trading meaning How does an investor, who has the underlying stock, use Stock Futures when he anticipates a short-term fall in stock price? How can an investor benefit from a predicted rise or predicted fall future and option trading meaning the price of a stock?

What is pair trading?

Margin is a very widely used word in financial terms, but it's unfortunately a word that is often very confusing for people. This is largely because it has a number of different meanings, depending on what context it is being used in.

In particular, the meaning of the term as used in options trading is very different to the meaning of the term as used in stock future and option trading meaning. The phrase profit margin is also future and option trading meaning common term, and that means something else again.

On this page we explain what the term margin means in these different contexts, and provide details of how it's used in options trading. Profit margin is a term that is commonly used in a financial sense in a variety of different situations. The simplest definition of the term is that it's the difference between income and costs and there are actually two types of profit margin: Gross profit margin is income or revenue minus the direct costs of making that income or revenue.

For example, for a company that makes and sells a product, their gross profit margin will be the amount of revenue they receive for selling the product minus the costs of making that product. Their net margin is income or revenue minus the direct future and option trading meaning and the indirect costs. Investors and traders can also use the term profit margin to describe the amount of money made on any particular investment.

For example, if an investor buys stocks and later sells those stocks future and option trading meaning a profit, their gross margin would be the difference between what they sold at and what they bought at. Their net margin would be that difference minus the costs involved of making the trades. Profit margin can be expressed as either a percentage or an actual amount. You may hear people refer to buying stocks on margin, and this is basically borrowing money from your broker to buy more stocks.

If you have a margin account with your stock broker, then you will be able to buy more stocks worth more money than you actually have in your account. If you do buy stocks in this manner and they go down in value, then you may be subject to a margin call, which means you must add more funds into your account to reduce your borrowings.

Margin is essentially a loan from your broker and you will be liable for interest on that loan. The idea of buying stocks using this technique is that the profits you can make from buying the additional stocks should be greater than the cost of borrowing the money. You can also use margin in stock trading to short sell stocks. Margin in futures trading is different from in stock trading; it's an amount of money that you must put into your brokerage account in order to fulfill any obligations that you may incur through trading futures contracts.

This is required because, if a futures trade goes wrong for you, your broker needs money on hand to be able to future and option trading meaning your losses. Your position on futures contracts is updated at the end of the day, and you may be required to add additional funds to your account if your position is moving against you.

The first sum of money you put in your account to cover your position is known as the initial margin, and any subsequent funds you have future and option trading meaning add is known as the maintenance margin. In options trading, margin is very similar to what it means in futures trading because it's also an amount of money that you must put into your account with your broker. This money is required when you write contracts, to cover any potential liability you may incur.

This is because whenever you write contracts you are essentially exposed to unlimited risk. For example, when you write call options on an underlying stock you may be required to sell that stock to the holder of those contracts.

If it was trading at a significantly higher price than the strike price of the contracts you had written, then you would stand to lose large sums of money. In order to ensure that you are able to cover that loss, you must have a certain amount of money in your trading account. This allows brokers to limit their risk when they allow account holders to write options because when contracts are exercised and the writer of those contracts is unable to fulfill their obligations, it's the broker with whom they wrote them that is liable.

Although there are guidelines set for brokers as to the level of margin they should take, it's actually down to the brokers themselves to decide. Because of this, the funds required to write contracts may vary from one broker to another, and they may also vary depend on your trading level.

However, unlike the requirements when trading futures, the requirement is always set as a fixed percentage and it isn't a variable that can change depending on how the market performs. It's actually possible to write options contracts without the need for a margin, and there are a number of ways in which you can do this. Essentially you need to have some alternative form of protection against any potential losses you might incur. Future and option trading meaning example, if you wrote call options on an underlying stock and you actually owned that underlying stock, then there would be no need for any future and option trading meaning.

This is because if the underlying stock went up in value and the contracts were exercised you would be able to simply sell the holder of the contracts the stock that you already owned. Although you would obviously be selling the stock at a price below the market value, there is no direct cash loss involved when the contracts are exercised.

You could also write put options without the need for a margin if future and option trading meaning held a short position on the relevant underlying security. It's also possible to avoid the need for a margin when writing options by using debit spreads. When you create a debit spread, you would usually be buying in the money options and then writing cheaper out of the money options to recover some of the costs of doing so.

Assuming you buy the same amount of contracts as you write, your losses are limited and there is therefore no need for margin. There are a number of trading strategies that involve the use of debit spreads, which means there are plenty of ways to trade without the need for margin. However, if you are planning on writing options that aren't protected by another position then you need to be prepared to deposit the required amount of margin with your options broker.

In reality, even if you are trading futures options this isn't something you really need to concern yourself with. However, you may hear the term used and it can be useful to know what it is.

The SPAN system was developed by the Chicago Mercantile Exchange future and option trading meaningand is basically an algorithm that's used to determine the margin requirements that brokers should be asking for based on the likely maximum losses that a portfolio might incur. SPAN calculates this by processing the gains and losses that might be made under various market conditions.

As we have mentioned, it's far from essential that you understand SPAN and how it's calculated, but if you do trade futures options then the amount of margin your broker will require will be based on the SPAN system.

Full Explanation of Margin Margin is a very widely used word in financial terms, but it's unfortunately a word that is often very confusing for people. Section Contents Quick Links. Profit Margin Profit margin is a term that is commonly used in a financial sense in a variety of future and option trading meaning situations.

Margin in Stock Trading You may hear people refer to buying stocks on margin, and this is basically borrowing money from your broker to buy more stocks. Margin in Futures Trading Margin in futures trading is different from in stock trading; it's an amount of money that you must put into your future and option trading meaning account in order to fulfill any obligations that you may incur through trading futures contracts.

Margin in Options Trading In options trading, margin is very similar to what it means in futures trading because it's also an amount of money that you must put into your account with future and option trading meaning broker.

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