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Futures and Options

What is Futures?

The futures also known as futures option is an option on a futures contract.

The futures option is common for both commodity futures such as oil and cotton contracts and financial futures such as dollars contracts.

Difference between Futures and options

  • The key difference between a futures option and an option on a futures contract's underlying advantage is delivery convenience.
  • A futures contract for 1000 barrels of oil is much easier to deliver than the oil itself. The futures option is therefore settled in cash only.
  • In this type of trading both parties must fulfill the contract on the settlement date.
  • The seller hands over the commodity to the buyer, or, if it is a cash-settled future, then cash is transferred from the trader who sustained a loss to the one who made a profit.

Live Example

Let's take an example to know this. Say I would like to buy a car of say half a million bucks but don't have enough cash for it right now. So I would need some time to arrange for it. Meanwhile I give some token amount (generally non-refundable) say 50000 bucks to the owner as advance and the rest in later time of two months.

Application

Now apply the same thing in stock market. An option is a contract that gives the holder the right, but not the duty, to make a specified transaction for a specified time. There are two types of options

The Call option

  • This is a kind of contract in finance between the buyer and the seller, and it is also referred as a "call"
  • Here buyer might buy a mutual amount of financial apparatus or commodity from the seller, so the buyer has the right but no obligation is involved there.
  • This buying happens from option-seller at a stipulated period of time which is known as expiration date and a fixed price that is referred as strike price.
  • The seller is also called as "writer" who is bound by the rule to sell the financial apparatus or commodity to the buyer as per the decision.
  • The buyer pays a certain amount of fee which is referred as premium for this particular right.

The Put option

  • It is a financial deed between two parties, the buyer and the writer of the option.
  • The put allows the buyer the right but not the obligation to sell a commodity or financial apparatus to the writer of the option at a certain time for a certain price.
  • The writer has the obligation to purchase the underlying apparatus at that strike price, if the buyer exercises the option.

Characteristics

  • Futures transactions can be made in three ways: squaring off, delivery and cash settlement.
  • Squaring off: This refers to taking a position opposite your initial one i.e. for example you square off the purchase of a gold futures contract by selling the same type of contract.
  • Delivery: This means physical delivery of any asset on a pre-settled date i.e. selling a gold futures contract of 500 grams then it is essential to physically present the gold to the buyer on a certain settled date.
  • Cash settlement: This involves paying the difference between the futures price and the spot price of the primary asset.

Online Transaction

For options transaction of options well that can be done online too

There are many software and referral books whose help a person can take to do the job done.

Points to Remember

  • An important factor to remember in dealing in futures and options is that they can be extremely risky and volatile.
  • Even with the most sophisticated, state-of-the-art trading systems, the trader however should be perceptive to bear this risk.
  • Never rely on a single source for the investment decisions on. The investments, in spite of everything, may thrive or vanish.

Case Study

The investor should always perform complete and thorough research and analysis from multiple sources and always consult a professional before making any investment decisions. Since it should be a general practice of a person to invest on a well-known and profitable platform the chances of forgery is minimum with that.


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