How to get rich quickly by investing?
Try F&O trading.
How to incur massive losses and lose everything in a jiffy by investing?
Try F&O trading.
For many investors, especially the impatient ones who want to get rich quickly without worrying much about the market fundamentals, F&O trading is so alluring. But, as they say, nothing comes without a price. F&O segment carries a very high risk and a single wrong decision can blow up the portfolio.
Take a look at the below tweet. A man took a loan for trading and lost all his money.
What is F&O?
Futures and Options, or F&O, are financial contracts the value of which depends on the underlying stock or an asset. In simple terms, the value of a stock, index, or commodity is moving up and down based on the underlying stock, index, or commodity.
So, basically Future and Option are two derivative instruments where the traders buy or sell an underlying asset at a pre-determined price.
Santosh Meena, Head of Research, Swastika Investmart explains ,'Futures' as a variant of derivative contracts where an individual decides to either sell or buy a specific amount of the asset at a pre-fixed price in the future. Future contracts are an excellent instrument to reduce the risk of price fluctuations.
'Options' are a different type of derivatives contract. In options, the seller or buyer has the right to purchase or sell a specific asset at a specific price at a pre-fixed date. There is no obligation, only the right to purchase or sell.
These instruments are extremely important in the financial world for risk management and hedging, however, due to human tenancy of instant gratification and becoming rich quickly, these hedging instruments have become speculative ones.
Trading in F&O has risks and benefits. The primary purpose of the derivative segment is to hedge against the price movement of the underlying asset.
Before you try it
For a trader, it is important to understand all the risks and benefits associated before entering into the pool of F&O trading. Unlike the cash market where risk is limited to the amount of capital deployed, the loss can be much more in the F&O segment.
Traders trade in the F&O segment to reduce or hedge the stock market risks by fixing the price earlier.
"Loss and profit are directly proportional to market volatility and a lot size of the underlying contracts, so one wrong trade can completely wipe out trader’s entire capital," Mohit Nigam, Head - PMS, Hem Securities, pointed out.
Nigam highlighted four major risks and benefits related to F&O trading:
1. Many individual stock options don't have much volume at all.
2. Unlike the cash market you cannot partially close a position and have to square off the position on expiry irrespective of profit and loss in the particular trade.
3. Some investment strategies can lead to high risks due to the leverage provided by future contracts.
4. Options sellers are exposed to unlimited losses and can sometimes incur losses much greater than the price of the contract.
1. Futures can bring added flexibility to one’s portfolio as future markets are usually highly liquid this allows traders to enter and exit the market at any time as per their own desire.
2. Futures and options are an excellent cost-efficient hedging device.
3. Sometimes the returns on buying options are much higher than on stocks. This is because a trader can get options by paying a lower margin and can get the same profitability as he would have received in the case of stocks, thereby earning a higher percentage return overall.
4. A trader can create unique strategies using various combinations of futures and options contracts to take advantage of different market conditions.
What if I use it only for intraday?
Contrary to what most people think, trading in the F&O segment is not easy and not for all.
"F&O trading is leverage trading and leverage itself is a dangerous thing. It is said that F&O trading is a zero-sum game but this is not the case because brokerage and other charges go to both the parties whereas impact cost is another big challenge for options traders," Meena explains.
The stock market is probably the toughest place in the world to make easy money. As per Zerodha, a renowned Indian broker, less than 1 percent of active traders earn more money than a bank fixed deposit over 3 years.
“My personal opinion to people is don’t trade. Out of 10 lakh, 9.99 lakh lose. Trading requires the basic defeat of the human ego, which very few people have. It needs recognition that markets go to extremes on both sides. There is nothing logical or reasonable here,” Meena quoted these lines of The Big Bull, Rakesh Jhunjhunwala on why F&O trading is not for all.
One needs to understand that F&O is not a bad thing. It is just highly risky and not suitable for all sorts of traders and investors.
As Meena says, F&O trading requires different kinds of skill sets including behavioral management and very few people possess them. One should learn the required skill set and start with less than 5 percent of their portfolio or even less in F&O trading.
And it is not just about the F&O trading. Every intraday trading carries a huge risk because it is largely based on momentum and is very little to do with fundamentals.
"Intraday trading is about risk management regardless of the segment that you trade in. In Intraday trading if you manage your risk well then only you can make money," said Animesh Malviya, an analyst at CapitalVia Global Research.
"Similarly F&O segment can be safe if you manage your risk to reward ratio and another important thing to keep in mind while trading intraday is to not take risk more than 1-2 percent of your capital in one position. If we can manage all the above points then F&O is also safe for intraday trading," Malviya adds.
Disclaimer: The views and recommendations made above are those of individual analysts and not of MintGenie.