Futures and options trading
Futures and options trading originated as a practice adopted by farmers and manufacturers for insurance like protection. They would fix a price for the crops at a future date so that they could plan their finances according to the price they would get for their crops. They could know for sure how much the money inflow would be at a certain date in future. In the same way the manufacturer could maintain consistency in his prices by fixing the exact price of his product in the future. The concept behind the options contract dates back to medieval times and it is in practice over centuries in the oil, manufacturing, imports and agricultural produce etc. The Futures and Options are collectively called derivatives.
Derivatives like Futures and Options are financial instruments the price of which is based on the price of the underlying security or asset or commodity. The basics of Futures and Options trading The Futures markets are the meeting places of buyers and sellers from all over the world. They are the auction markets that determine the demand supply positions on a continuous basis. The products include financial instruments, stock indexes, US Treasury Bonds and currencies in addition to the conventional products like commodities, metal and petroleum products. The advanced electronic and communication technologies have helped the Futures and options trading to diversify into multiple opportunities. The markets have become accessible to more traders worldwide. The Futures and Options markets provide the opportunity for better returns than the other markets and the placing orders electronically has changed the way people trade and it has opened the doors for greater diversification for their investment portfolios. They also help in reducing the risk by offering better returns if done in combination with a variety of other forms of investments.
Trading in Futures markets Though the Futures markets are similar to stock markets there are some important differences between these two markets. The Futures trading is considered as a more attractive investment. When the prices assume a high volatile nature, the price is controlled and limited by fixing daily price limits so that the price movements are restricted from moving beyond the predetermined limit. The simple formula that can make a Futures trader successful is to buy low and sell high. Similarly it is profitable if you sell high and buy
back low in the Futures market. For trading in the Futures market the investor buying a call or put option. The investor who buys the call option expects the price to go up, and thinks that he can make profit by buying it and selling at a future date. Advantages The advantage here is the heavy loss if the price drops is minimal as the buyer can choose not to buy the underlying instrument but ready to loose only the cost of the call option. Thus the buyers of a call option are those who speculate on the rise in price which is safe and the loss can be controlled. There is no obligation to take delivery of the underlying instrument which means there is no necessity for locking a large amount of money for uncertain periods by waiting for the right price to sell. On the contrary, the option buyer looks forward to a drop in the price of the underlying asset. In the event of the price increase, the loss is limited to the cost of buying the put option and not the total cost of the underlying asset itself. These options are issue for a minimum period of 21 days and happen in one, two, three or six months duration. Risk involved in the futures and options market The Futures and Options market is extremely risky and volatile. So care must be taken not to invest in a single source of information based on which the trading decisions are taken.
A good understanding of the Futures market is a must. Also the investor should go through the research and analysis from various sources and make investment decisions. Consulting a professional is a good idea too. National Futures Association (NFA) can provide the investor with details about companys registration status. They serve as information source related to Futures trading and receive complaints and also settle disputes. Trading Strategies of Futures and Options trading markets The Futures and Options markets are where the future value of a commodity or index will be on a fixed date. The traders use three major strategies namely, going long, going short and spreads. When the investor enters into a Futures contract to buy and take delivery of a certain volume of the commodity or stock at a set price with the intention of selling it at a higher rate, as he expects that the price would move up. The trader goes short when he enters into the contract for selling and delivering the specific quantity of commodity or stock at a set price so that he can buy it back at a lower price as he expects the price to decline and profit thereby. The spreads are contracts that take advantage of the price differences of the same commodity or stock. This is a conservative method but safe form of trading that yields moderate profits. There are different options available to the trader like calendar spreads, inter-market spreads and inter-exchange spreads.
Futures Contract The Futures Contract is a contract which is traded on a Futures Exchange to buy or sell an underlying instrument on a specific delivery date, also called settlement date at a set price. This is the price of the Future that is being traded. The price of the instrument on the settlement date which is arrived at by the exchange. The contract can be settled by physical delivery or by cash payment. On the delivery date, both the buyer and seller should fulfill the obligation under the settlement. There are two types of traders in the Futures market. They are hedgers, who are usually the farmers who produce the commodities who try to hedge and minimize the risk of price fluctuation. The other type consists of speculators who engage in the trading to make profits out of the price fluctuations. Options Contract The options contract is a derivative representing an underlying security that entitles the contract owner to exercise the contract and the seller is obligated to fulfill the contract. The Options contract contains details such as the option type, whether it is a call or put the strike price or exercise price and its date and the quantity of the underlying security. The delivery should be made and received on the same date which is the date of the settlement. The investor can make good profits in Futures and options trading but he should understand the markets and the trends thoroughly before putting his money in it. The speculative high risk high profit nature of this market is the very reason why most of the speculators make lots of money by having the Futures and Options trading as a part of their diversification in his portfolio.
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