F&O (Futures and Options) Trading

1. What Are Derivatives?

Futures and Options are derivative instruments, meaning their value is derived from an underlying asset. This underlying can be:

Stocks

Indices (NIFTY, BANKNIFTY)

Commodities

Currencies

The underlying’s price movement directly influences the F&O contract.

2. What Are Futures Contracts?

A Futures contract is an agreement to buy or sell an asset at a predetermined price on a specific future date. Both parties are obligated to fulfill the contract.

Key Features of Futures

Obligation: Buyer must buy, seller must sell.

Standardized: Lot size, expiry date, and price movement rules are fixed by the exchange.

Margin Required: Traders don’t pay full contract value; they pay a margin (~10–20%), which offers leverage.

Daily MTM: Profits or losses are settled daily through Mark-to-Market.

Example

If you buy NIFTY Futures at 22,000 and NIFTY rises to 22,200, you gain 200 points × lot size.
If NIFTY falls, you face losses.

Where Futures Are Used

Speculation: To profit from price movements

Hedging: To protect portfolios from adverse market moves

Arbitrage: To profit from price differences between spot and futures markets

Futures are powerful but risky due to high leverage.

3. What Are Options?

An Option is a contract that gives the buyer the right, but not the obligation*, to buy or sell an underlying asset at a specific price before (or on) expiry.

Two Types of Options

Call Option (CE) – Right to buy

Put Option (PE) – Right to sell

Two Sides of Options

Buyer (Holder): Pays premium, risk limited

Seller (Writer): Receives premium, risk can be unlimited

Strike Price

The price at which you may buy or sell the underlying.

Premium

The price paid by option buyers.

4. How Option Buyers Make Money
Call Buyer

Profits when underlying price goes above strike price + premium.

Put Buyer

Profits when underlying price goes below strike price – premium.

Buyers have limited loss (premium) and unlimited profit potential.

5. How Option Sellers Make Money

Sellers receive the premium upfront.

They profit when:

Price does not move beyond breakeven

Option expires worthless

Time decay eats option value

But sellers face unlimited loss risk, especially in naked selling.

That’s why option selling must be done with proper hedging and risk management.

6. Expiry and Settlement

F&O contracts expire on:

Weekly expiry: Every Thursday (Index options)

Monthly expiry: Last Thursday of every month

After expiry, contracts settle based on closing prices of the underlying.

7. Margin and Leverage

Futures require margin to control large positions.
Example:

NIFTY lot size: 50

NIFTY at 22,000 → Contract Value = 11,00,000

Margin required ≈ ₹1,40,000

This leverage amplifies gains and losses.

Options buyers pay only the premium, no margin.
Options sellers must pay heavy margins because of high risk.

8. Why Traders Use F&O?
A. Hedging

Investors use F&O to protect their portfolios.

Example:
If you own Reliance shares, you can buy a Put Option to hedge downside risk.

B. Speculation

Traders try to profit from price movements using leverage.

Example:
Buy BANKNIFTY 500-point movement with small capital by using options.

C. Arbitrage

Exploiting price differences between:

Spot and Futures

Option prices (mispricing)

Arbitrage is low-risk and often executed by institutions.

9. Option Pricing Factors

Option premiums are affected by:

1. Intrinsic Value

Value if exercised today.

2. Time Value

More time → higher premium.

3. Volatility

Higher volatility → higher premium.

4. Interest Rates

Small effect, but important for indices.

5. Demand/Supply

Market sentiment impacts prices.

The most important factors in India’s F&O market are volatility and time decay.

10. Greeks: The Heart of Options Trading
1. Delta

Measures price sensitivity.
Call Delta: 0 to 1
Put Delta: 0 to –1

2. Gamma

Rate of change of Delta.

3. Theta

Time decay.
Option buyers hate Theta; sellers love it.

4. Vega

Effect of volatility on premium.

5. Rho

Effect of interest rates (least used).

Understanding Greeks is essential for advanced F&O trading.

11. Popular F&O Strategies
Directional Strategies

Long Call

Long Put

Short Futures

Long Futures

Non-Directional Strategies

Straddle

Strangle

Iron Condor

Butterfly

Hedging Strategies

Protective Put

Covered Call

Collar Strategy

Traders use these based on market conditions and risk appetite.

12. Risks in F&O Trading
1. Leverage Risk

Small price movements can cause huge losses.

2. Unlimited Loss in Option Selling

Selling naked options is extremely risky.

3. Margin Shortfall

If losses exceed margin, broker issues margin calls.

4. Time Decay

Options buyers lose value every day.

5. Volatility Crush

After major events (budget, result days), volatility drops, premiums fall rapidly.

13. Benefits of F&O Trading
1. High Liquidity

Especially in NIFTY and BANKNIFTY.

2. Hedging Power

Protects portfolio from adverse moves.

3. Leverage

Makes it possible to trade large positions with moderate capital.

4. Strategy Flexibility

Works in bull, bear, and sideways markets.

5. Potential for High Returns

When used correctly.

14. F&O in Indian Markets

India is one of the world’s largest F&O markets due to:

High retail participation

Weekly indexes options

Attractive margins

High volatility in indices

Index Options (NIFTY & BANKNIFTY) dominate over stock options.

15. How to Trade F&O Safely

Use stop-loss always

Avoid naked option selling

Stay aware of global markets

Track volatility (India VIX)

Use hedged strategies

Do not overleverage

Maintain discipline

Book profits regularly

Conclusion

F&O trading is a powerful tool for traders and investors, offering leverage, hedging benefits, and the ability to profit from different market conditions. However, F&O trading carries significant risk, especially due to leverage, time decay, and volatility. With proper risk management, strategy, and knowledge of options Greeks, traders can use F&O to enhance returns and protect their portfolios. For beginners, understanding the basics and practicing with small positions is crucial before jumping into advanced strategies or large trades.