Futures & options (F&O) are derivative financial products that help traders to earn money or to hedge their investment against future losses. Options contract gives the buyer an option to buy shares at a pre-decided price any time before the contract’s expiry. Futures contracts are the ones wherein two parties get into contract to buy or sell securities at a future date at a predetermined price.
The investors who look forward to trading in futures and options are supposed to know a few key terms:
Call option: This gives the buyer an option, but not an obligation, to buy a security at a predetermined price any time before the expiry of the contract from the seller (writer).
Put option: This financial derivative contract gives the buyer an option to sell the underlying asset at a fixed price any time before the expiry of contract to the seller (writer).
Option holder: The buyer of the contract is known as option holder. It’s the holder who has the ‘option’ to exercise.
Option writer: The seller of options contract is ‘writer’ who is supposed to honour the contract where the right of purchase (call) or sale (put) is entrusted with the other party i.e. the holder.
Futures contract: Futures are derivative contracts that allow for the sale of an asset at a future date at a predetermined price. They protect the traders from incurring losses that might happen due to sharp fall in prices.
Strike price: The price at which a call or put option can be exercised is known as strike rate.
Hedging: It is a form of investment made to reduce the risk of unanticipated price changes of an asset. A hedge usually entails taking a position contrary to the investment that is being hedged. It is also compared to an insurance policy.
Option premium: It is the amount paid by the buyer (holder) to the seller for selling them the ‘right to buy’ or ‘right to sell’ in case of call and put, respectively. In other words, it is the income received by the seller of options contract.