UNDERSTANDING F&O: MEANING, RISKS, AND REASONS TO INVEST

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Future and Options, commonly referred to as F&O, are key derivatives. Here, stocks and indices are the underlying assets.

A closer look at the workings of derivatives

Before we move forward, let’s spend some time to understand derivatives in greater detail, as Future and Options fall in this category. As the name suggests, a derivative is a contract that derives its value from an underlying asset. These assets can be stocks, bonds, commodities, currencies, interest rates and market indices etc. 

These financial instrumentswork like a simple sale-purchase contract between a buyer and a seller, barring one major difference. In derivatives, the two parties involved bet against the future price of the underlying asset.  You know that markets keep fluctuating owing to constantly-changing demand-and-supply dynamics and other triggers. Consequently, so does the value of the underlying asset. The derivatives contract is therefore executed at a pre-determined price on or before a specific date. Thus, these contracts help you minimise the risks associated with the transaction and/or earn profits.

What are Futures and Options

In this type of contract, you can trade on exchanges against a stock or index at a pre-determined future price and date. Thus, you minimise the risks associated with the stock market. This is also known as hedging.

Advantages of F&O trading include:

  • Margins: You have to pay only a margin for the purchase of assets.
  • Liquidity & transparency: In F&O, you will have to purchase shares of a company in lot size, and in bulk. They are traded on regulated exchanges. These factors  ensure high liquidity and transparency levels. 
  • Low commission:  The commission charge in F&O contracts is low.
  • High profits: The greater the risk, the greater  the reward. This adage holds true for F&O trading, and you will make more profit as compared to stock trading.
  • Hedging & speculation: With F&O, you  have the advantage of minimising risks.

Risks involved in F&O trading include:

  • High risk: Since you hedge against the future price of your assets, which is unknown, F&O trading is inherently risky. 
  • Leverage:  The entire share capital is controlled with a small sum of money. The value of the margin is typically only 10% of the total value.
  • Expiry date:  F&O trading comes with an expiry date. You have to square off  your positions on that  date, notwithstanding the value of the asset.  
  • Margin could increase
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  • We have seen that futures and options are derivates. You can trade equities, commodities, currencies, rates of interest, and market indices with these financial instruments..

At Geojit, we can help you with derivative trading in several ways, from facilitating trade in multiple derivative products via numerous platforms to providing in-depth research and analysis. We strive to help you manage the risks and enhance your chances of making a profit with the appropriate guidance and state-of-the-art equipment and technology. Click here to learn more about our services offered in F&O.

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