Trading in Futures & Options

B Gopkumar

The Futures & Options (F&O) segment, also known as the derivatives markets, on the stock markets is the fastest growing segment in the country. In the past seven years, the National Stock Exchange (NSE), India’s largest derivative exchange, has seen its F&O segment growing more than 150% while the trades on the cash market have grown by only 34%.

Of the Rs 1.04 lakh crore daily traded volume on the NSE, close to 94% comes from the derivative segment. Further, close to 78% (approximately Rs 85,000 crore daily volume) is from the option segment. On the other hand, the cash segment accounts for only 6% (approximately Rs 7,000 crore of the daily volume).

Interestingly, the mobile-trading platform has become the preferred choice for investors with F&O trading via mobile application growing more than three times or 170% in FY 15-16. More than 90% of the trades on mobile are derivative trades.

This makes trading in the derivative segment, especially the option segment, worth evaluating for investors.

Interestingly, a large portion of the option trades is dominated by retail investors who have a view on a stock or index. Options’ trading provides investors an opportunity to ride on equity movements without purchasing the underlying securities. Yet, only a small fraction of people utilise them in building their portfolios.

Many investors consider these instruments too complex and risky, which, in many cases, can provide a superior risk/reward ratio than simply purchasing the underlying equity.

Of course, trading in the derivative segment requires some commitment in terms of time to learn how to trade and then track your trade. As technology advances, several big broking houses have developed trading applications to help investors trade in derivative markets. These applications use live robots for analytics to offer real-time market scanners to the investors and thereby eliminate tedious excel sheet computation currently done by traders.

These applications capture and process predefined market watch for Nifty, Bank Nifty and other indices with real-time market update with advanced technical charting support.

Is trading in F&O different?

Trading in the derivative segment is very similar to trading in the cash markets, but trading in F&O lets you get over the limitations of trading in the cash market. It can be used to hedge and protect your existing portfolio. It can also help you rollover your position up to three months. Obviously, the next question is: What is the kind of money that one can make in the F&O market and what is the risk attached? If you are a buyer in the futures market, there is no limit on the profit/loss that you make.

A futures contract carries unlimited profit and loss potential whereas the loss of a buyer of a Call or Put option is limited, but the profit potential is unlimited. A call writer makes money when the markets don't go up above a certain point and a put writer if the markets don't go down below a certain point.

For beginners, it is advisable to start off with buying options rather than writing/selling them. Once you get a hang of how the business works, you can look at writing/selling as well.

Risk associated with F&O

Since there is a risk of losing money fast, the most important rule while trading in F&O is to be very conservative.  Ideally, F&O should not exceed more than 15 to 20% of your investible capital. The best way to start is by knowing what the profitable traders are doing. It is here that the new application developed by niche broking houses gives the investor an edge.

Some of these applications can scan over 25,000 contracts, 5,000 securities per second and identify specific opportunities for covered calls, covered put, long straddle with highest implied volatility. It allows investors to take calculated decisions and helps them get options contracts filtered and listed under strategies like covered call, covered put, long straddle with highest implied volatility.

One should definitely "paper trade" for a while until one gets comfortable with the process. Most brokers have 'virtual trading' platforms that are free to use if you open an account and many don't require any deposit for using the virtual trading platform.

The writer is CEO of Reliance Securities. The views expressed in this article are his own