What Is Futures And Options Trading?

[00:00:00] Hey folks CA Rachana Ranade here and I welcome you all to another episode of Finance Simplified,

[00:00:05] the podcast Futures & Options. So let's get started.

[00:00:11] Many people might be just knowing what is F&O? It's futures and options but exactly what

[00:00:16] is F&O? Simple. It's a type of derivative right? Now you might be wondering earlier we didn't

[00:00:22] know what is F&O. Now we don't know one more term and what is that? Derivative.

[00:00:26] If you want to know derivatives check out it in the next section. Now let's understand

[00:00:31] exactly what do we mean by derivative? If you want to go by theory first, theoretically

[00:00:36] or by definition derivative is a financial instrument which derives its value from an

[00:00:41] underlying asset and I'm sure you have understood nothing correct? So let me explain

[00:00:46] it properly one by one. What is it? It's a financial instrument shares financial

[00:00:51] instrument bonds. It's a financial instrument similarly derivatives is what? It's a financial

[00:00:56] instrument okay so like you can invest in shares, you can invest in bonds, you can invest

[00:01:00] in debentures similarly you can invest in derivatives fair enough. So it's a financial

[00:01:05] instrument which derives its value. It derives its value means it gets its value from

[00:01:10] an underlying asset. I'll give you a very simple example to start off with okay

[00:01:15] visualize that you are having something like a payback card. If you have heard

[00:01:20] then you will understand this in one second. Payback card is not a debit card it's not

[00:01:25] a credit card, it's a card in which you just gain points okay. Now how do you gain

[00:01:30] the points? You gain points only when you swipe your debit card or swipe your credit

[00:01:35] card okay. Now this payback the value of this payback or the points increase only

[00:01:41] if your debit card spends increase or your credit card spends increase okay. So

[00:01:46] the value of the points increases when the underlying is your debit card or

[00:01:51] credit card the spends increase. So the payback derives its value from the

[00:01:56] underlying asset which is a debit card or a credit card. This is a very crude way

[00:02:00] but it's a very simple way of explaining what is a derivative. I'll give you

[00:02:04] practical examples now. For example there is a derivative of let's say a stock

[00:02:10] of reliance industry's derivative like reliance industry's derivative okay. If I'm

[00:02:15] saying that it's a future of reliance industry okay. The future of reliance

[00:02:20] industry value will increase only when the underlying which is the stock of

[00:02:24] reliance industries increases. So one more time if the value of stock of

[00:02:28] reliance industries increases automatically the derivative of reliance

[00:02:31] industry's value will also increase. Number 1, number 2 example let me give

[00:02:36] you a commodity derivative what could be a commodity simple example can be

[00:02:39] wheat I have bought a wheat derivative when will be the value of wheat

[00:02:43] derivative increase it will increase only when the value of the underlying

[00:02:47] asset increases. What is the underlying asset? It's wheat if wheat value increases

[00:02:51] the derivative increases if weight value decreases the derivative value will

[00:02:55] decrease right one more example. I'm talking about currency derivatives let us

[00:03:00] say and I'm talking about US dollar derivative when will US dollar

[00:03:03] derivative value increase only when the US currency becomes stronger if US

[00:03:09] dollar increases then automatically the US derivative will increase okay. So what

[00:03:14] is a derivative one last time it is a financial instrument which derives its

[00:03:18] value from the underlying asset okay I don't think there can be any more

[00:03:23] examples okay one last example actually one last example what could be a

[00:03:27] derivative it could be an index derivative also okay like a nifty

[00:03:30] derivative nifty derivative the value will increase only when the underlying

[00:03:34] asset what is underlying asset nifty if nifty increases nifty derivative will

[00:03:38] increase if nifty goes down nifty derivative will also go down okay and on

[00:03:44] a lighter note I can say that you all are a derivative okay and I'm the

[00:03:50] underlying asset why because you are deriving knowledge from my knowledge

[00:03:56] okay if I have a stronger knowledge if I increase my knowledge automatically your

[00:04:00] knowledge is going to increase right so always remember me as the derivative

[00:04:04] and the underlying concept. Now let's come to what are the types of

[00:04:10] derivatives because I'm sure you might have heard a lot of people talking

[00:04:14] about stock market wherein they say that we have taken a position of

[00:04:17] futures or options but you might not have heard people saying that I

[00:04:21] bought a derivative okay but now I'm sure everyone knows what's a

[00:04:25] derivative so now it's time to understand what are the different types of

[00:04:28] derivatives. So here are the different four types of derivatives wherein we

[00:04:31] say forwards futures options and swaps these are primarily four types of

[00:04:37] derivatives okay but as far as the stock market is concerned

[00:04:40] forwards and swaps they don't form a part of trading okay so can you trade

[00:04:48] in futures yes can you trade in options yes exactly what is the difference

[00:04:53] futures options that itself is a different content of a lecture so again

[00:04:58] if you want to know more about exactly what's a future what is a what is an

[00:05:03] option what is a call what is a put that itself makes a separate lecture

[00:05:06] let me know and I'll definitely make a separate lecture on these content as

[00:05:09] well. Now that you have understood what is a derivative what are the

[00:05:15] different types of derivatives only futures and options can be traded

[00:05:19] on the stock market the whole question is that why derivatives even exist okay

[00:05:24] there's an amazing thing which is there about derivatives and for that you need

[00:05:28] to understand that derivatives are primarily used for two major things

[00:05:32] which are the two major things one is for hedging and one is for speculation

[00:05:36] okay if I'm talking about the simple one first is speculation speculation

[00:05:41] comes from the normal English word to speculate to speculate means I'm

[00:05:45] just trying to bet on something okay don't look at it from a negative sense

[00:05:49] that finally stock market is betting and satire and all that betting means

[00:05:53] what I'm trying to you know trying to gauge as to what will be the direction

[00:05:59] of the market so for example if I feel that market will go up okay then

[00:06:03] what am I doing I'm speculating that market will go up I'm thinking I'm

[00:06:07] feeling that market will go up okay am I doing am I taking this position

[00:06:11] to earn profit yes okay if I feel that markets are going down or markets might

[00:06:17] go down what I will do I will do a short sale okay what do we mean by short sale

[00:06:22] in simple words you sell first and you buy later okay I'll give a simple example on this

[00:06:28] when market was around 9500 I thought that there is a great chance that

[00:06:33] market will fall down okay so what did I do I sold nifty and now you know

[00:06:39] nifty derivatives can be sold because underlying asset is nifty okay and what

[00:06:44] is the derivative nifty future or nifty option will be the derivative so what did

[00:06:48] I do I sold nifty at 9500 level if the market goes down and down and down

[00:06:53] what will I do let's say the market goes down from 9500 to 8000 level okay

[00:06:58] will I be happy yes why because I've sold at 9500 and if if the market

[00:07:03] really goes down to 8000 level this 1,500 gap is my profit

[00:07:08] because what I will do is when market goes down to 8000 level that is when I

[00:07:12] will buy check this out will it be one and the same buying at 8000 first and

[00:07:17] selling at 9500 case 1 versus case 2 selling at 9500 first and then buying

[00:07:24] at 8000 finally it's bottom to top top to bottom but then where's the

[00:07:29] difference the difference is that if market is at 9500 right now and if

[00:07:34] I feel it will go down that is where derivatives come into play I can sell

[00:07:39] my position first I can wait back I can relax so right now even if market is

[00:07:44] going a little bit up and down I'm still I have not still close the position

[00:07:48] what do you mean by I've still not closed the position I've sold at 9500

[00:07:52] and that position still exists so I'm just praying every day so whenever I read

[00:07:56] the newspaper and I see that market is going down whenever news channel say

[00:07:59] market is going down I'm like very happy because the target is that it

[00:08:02] should go down to a good level if it goes down that's when I'm going to make profit

[00:08:06] okay so why did I take this position I took a position to speculate my

[00:08:11] speculation my thought process was that market will go down and that is why

[00:08:15] I entered into this position fair enough yes this is part 1 speculate part

[00:08:20] 2 why do I take a derivative position is because I want to hedge my position

[00:08:24] what do we may what do we mean by hedge hedge means I enter into the

[00:08:29] position to reduce my losses okay so please understand again what is the basic

[00:08:34] difference between hedging and speculation my primary intention of speculation

[00:08:39] is to earn profit but my primary intention of hedging is to reduce my losses

[00:08:44] okay so why or how can I do that simple assume that I had bought many shares

[00:08:50] in my portfolio when market was at 11500 was at 12000 was at 12400 also

[00:08:55] so you can imagine I have bought stocks worth rupees 10 lakhs

[00:08:59] okay or 10 crores whatever I can say any amount right so I bought stocks worth

[00:09:03] rupees 10 crores let us say what can happen because the market is going down

[00:09:07] there's a great possibility that the value of stocks which was 10 crores is now

[00:09:11] maybe 5 crores okay so I know that my value of my portfolio is going to go

[00:09:16] down now to reduce this losses I want to enter into a profit position

[00:09:21] I want to compensate for that losses and if I want to take a position to

[00:09:25] compensate for the losses that is where I say I enter into a derivative

[00:09:29] contract with an intention to hedge my position okay so that is hedging

[00:09:35] see finally how do you trade whether you buy or whether you sell

[00:09:40] it is going to be the same how do you differentiate hedging and speculation

[00:09:44] it is the intention okay if your intention is to only earn profits

[00:09:48] it is pure speculation if your intention is to minimize your risks minimize

[00:09:52] your losses that is where we call it as hedging okay I have not

[00:09:56] talked about any strategy as of now I just wanted to clarify the difference between

[00:10:00] hedging and speculation and very important why derivatives exist

[00:10:04] thank you for joining us on this episode of finance simplified I hope you enjoyed

[00:10:08] listening to this podcast and also found some value in it if you did don't forget to share it

[00:10:12] with your friends and relatives till then take care Jai Hind and bye