Futures and Options

In this video we’ll learn about futures and options and our
main focus would be in options
As we know to deal in the market we must trade in equity ,
futures and options. Futures and options are known is
derivatives.
Derivatives means the value of security derived from the
asset so the asset is known as underlying here.
• In financial market the underlying are stocks , bond,
commodity, currency, and indices whereas the derivatives
are its futures and options.
• To understand the options we must first understand what
is futures and to understand futures we must understand
what is forward.
Forward Contracts
• A forward contract is an agreement between two parties to buy or sell an asset at a
specified future date for a price agreed upon today. Unlike futures contracts, forwards are
not standardized and are traded over-the-counter (OTC), meaning they are privately
negotiated and not traded on an exchange.
• Let us understand how forward contract work :
• You are a wheat farmer and expect to harvest 10,000 bushels of wheat in six months. You
are concerned that the price of wheat might fall by the time you are ready to sell your crop.
To protect yourself against this price risk, you enter into a forward contract with a buyer who
needs wheat in six months.
• Terms of Forward contract :
• Quantity: 10,000 bushels of wheat
• Price: rs. 250 per bushel
• Delivery Date: Six months from today

• You and the buyer agree on the terms of the forward contract. You both agree that in six
months, you will sell and the buyer will buy 10,000 bushels of wheat at rs.250 per bushel,
regardless of the market price at that time.
 Scenarios

Scenarios You(Seller) Bakery(Buyer)

If the market price of wheat falls to rs.200 You effectively gain 50rs. per The buyer pays 50rs. more per
per bushel in six months, the forward bushel (rs.250-rs.200) compared bushel than the market price,
contract protects you from the price to selling at the market price. resulting in a higher cost for the
decline. You sell your wheat at the agreed wheat.
price of rs.250 per bushel, even though
the market price is lower. The buyer pays
you rs.25,00,000

If the market price of wheat rises to rs.300 You forgo the additional rs.50 The buyer effectively gains 50rs.
per bushel in six months, you still have to per bushel (rs. 300 –rs.250) that per bushel by paying less than the
sell your wheat at the agreed price of you could have earned by market price.
rs.250 per bushel. The buyer benefits by selling at the market price.
buying the wheat at a lower price than the
market price.

The market price of the bushel stays same No profit- no loss No profit – no loss
 Risk Involved

Liquidity Risk :The risk that

Default Risk :The risk that
you cannot buy or sell a
the other party in a financial
futures contract at the
contract will fail to fulfill
desired price due to
their obligations.
insufficient market activity.

Rigidity :The risk that the

Regulatory risk :The risk that
standardized nature of
changes in laws or
futures contracts may not
regulations will negatively
perfectly align with the
impact your trading
specific needs or timing
activities or strategies.
requirements of the trader.
Futures advantages
So as you have seen risk is involved in forward then we can
say that .Future is better as it is modified version of forward:
•Standardization: Futures are standardized in terms of contract size
and expiration, improving liquidity and pricing transparency.
•Exchange-Traded: Futures are traded on organized exchanges,
providing a centralized marketplace with greater liquidity.
•Clearinghouse: A clearinghouse guarantees trades, reducing
counterparty risk.
•Mark-to-Market: Futures are settled daily, reducing the risk of large,
unexpected liabilities.
•Margin Requirements: Initial and maintenance margins provide a
financial buffer, lowering the risk of default.
•Liquidity: Higher liquidity in futures due to standardization and
exchange trading.
•Regulatory Oversight: Futures are subject to strict regulation,
ensuring fair practices and market integrity.
Let us understand the example but by keeping the futures
in mind:
Contract value is 25,00,000 in the previous example
And lot size was 10,000.
Expiry means the that after which the contract does not have any
value and in our example after 6 month it will not have any value.
In futures margin money is taken i.e., some money is taken in
advance so that if there is any loss it could be covered.
 • Options is like hedging
tool .We can see hedging as
insurance as we buy insurance
for car safety . Similarly the
options can be used to buy call
or put according to the
decision of whether the stock
Options will be going up or down.
Options were introduced as a
hedging tool, people used
them for speculation.
• There are two types of option:
1. Call Option
2. Put Option
 • A call option is a contract that gives the buyer the right,
but not the obligation, to purchase a specified quantity of
an underlying asset at a predetermined price within a
specified period.
• Option jargons :

Call Option 1. Strike Price: The price at which the buyer of the call
option can purchase the underlying asset. This price is set
when the option contract is created.
2. Expiration Date: The date on which the option expires.
After this date, the option is no longer valid.
3. Premium: The price paid by the buyer to the seller (writer)
of the option for the rights conferred by the option. This is
paid upfront and is non-refundable.
 •Buying a Call Option: When you buy a call option, you are purchasing the
right to buy the underlying asset at the strike price before the expiration
date.
•Example: Suppose you buy a call option for 100 shares of Company XYZ
at a strike price of rs.50, expiring in one month, and you pay a premium of
rs.2 per share. The total cost of the option is rs.200 (100 shares x rs.2).

Understand this •Exercising the Option: If the price of the underlying asset rises above the
strike price before the expiration date, you can exercise the option.
•Example: If the price of Company XYZ’s shares rises to rs.60, you can

with help of an exercise the option to buy 100 shares at 50 each. Your profit per share is
rs.10 (60 market price - 50 strike price), minus the rs.2 premium, resulting in
a net profit of rs.8 per share.

example: •Letting the Option Expire: If the price of the underlying asset does not
rise above the strike price before expiration, the option will expire worthless.
You lose the premium paid.
•Example: If the price of Company XYZ’s shares remains at rs.50 or falls
below, you would not exercise the option since buying at rs.50 when the
market price is the same or lower makes no sense. You lose the rs.200
premium paid.
Put Option

• A put option is a financial contract that gives the buyer the right, but not the obligation, to sell a specified quantity of
an underlying asset at a predetermined price within a specified period.
• Let us understand it with an example :
1. Buying a Put Option: When you buy a put option, you are purchasing the right to sell the underlying asset at the
strike price before the expiration date.
Example: Suppose you buy a put option for 100 shares of Company XYZ at a strike price of rs.50, expiring in one
month, and you pay a premium of rs.2 per share. The total cost of the option is rs.200 (100 shares x rs.2).
Scenario 1: If the price of the underlying asset falls below the strike price before the expiration date, you can exercise
the option.
Example: If the price of Company XYZ’s shares falls to rs.40, you can exercise the option to sell 100 shares at
rs.50 each. Your profit per share is rs.10 (50 strike price - 40 market price), minus the rs.2 premium, resulting in a net
profit of rs.8 per share.
Scenario 2:If the price of the underlying asset does not fall below the strike price before expiration, the option will
expire worthless. You lose the premium paid.
Example: If the price of Company XYZ’s shares remains at rs.50 or rises above, you would not exercise the option
since selling at r.50 when the market price is the same or higher makes no sense. You lose the rs.200 premium
paid.
Option Buyer vs Option Seller
Feature Option Buyer Option Seller

Rights & Obligations Right, not obligation Obligation

Premium Pays premium Receives premium

Unlimited (call); significant Limited to the premium

Profit Potential
(put) received
Unlimited (call); significant
Loss Potential Limited to the premium paid
(put)

Primary Motive Speculation Income generation

Time Decay Impact Works against the buyer Works in favor of the seller
 • Scenario: You believe that the stock of XYZ

Let just
Company, currently trading at ₹1000, will rise
significantly in the next month.

understand • Action: You buy a call option with a strike price of

₹1100 expiring in one month. The premium for this
option is ₹50 per share.
it with the • Cost: You pay ₹5000 for the option (since options

help of contracts are typically for 100 shares: ₹50 * 100 =

₹5000).

example • Possible Outcomes:

• Stock Price Rises Above ₹1100: Suppose the
from call stock price rises to ₹1300 by expiration. You can
exercise the option to buy the stock at ₹1100

option
and then sell it at the market price of ₹1300,
making a profit of ₹200 per share.
• Profit Calculation: (₹1300 - ₹1100 - ₹50) *
buyer poin 100 = ₹15,000.
• Stock Price Stays Below ₹1100: The option
of view expires worthless, and your loss is limited to the
premium paid, which is ₹5000.
 • Scenario: You believe that the stock of XYZ Company will
not rise above ₹1100 in the next month.
1. Action: You sell a call option with a strike price of ₹1100
expiring in one month. You receive a premium of ₹50 per
share.

Example 2. Income: You receive ₹5000 for selling the option (₹50 *
100 = ₹5000).

from call 3. Possible Outcomes:

1. Stock Price Stays Below ₹1100: The option

option expires worthless, and you keep the entire premium

as profit.

seller point
1. Profit Calculation: ₹5000 (premium received).
2. Stock Price Rises Above ₹1100: Suppose the
stock price rises to ₹1300 by expiration. You are

of view obligated to sell the stock at ₹1100.

1. Loss Calculation: You need to buy the stock at
the market price (₹1300) and sell it at the strike
price (₹1100), resulting in a loss of ₹200 per
share, but you keep the premium received.
2. Net Loss: (₹1300 - ₹1100 - ₹50) * 100 =
₹15,000
Summarized
format:
•From above example Call Option Call Option
Scenario
•Option Buyer: The buyer
Buyer Seller
benefits from significant Stock Price Profit: Loss:
movements in the underlying rs.15000
asset's price, with the Rises to rs.1300 rs.15000
maximum loss being the
premium paid. Profit:
•Option Seller: The seller Stock Price Loss: rs.5000
rs.5000
profits from the premiums if Stays Below (premium
the asset's price does not rs.1100 paid) (premium
move significantly but faces
potentially unlimited losses if received)
the price moves substantially
against their position.
•
Open Interest
• Open interest (OI) is a crucial concept in trading, particularly in
futures and options markets. It represents the total number of
outstanding derivative contracts, such as futures or options, that
have not been settled. Open interest can provide valuable insights
into market sentiment and the strength of price movements.
• Here's a detailed explanation with an example:
When a new contract is created (a buyer and a seller agree on a
trade), open interest increases by one. When a contract is closed
(either the buyer or seller exits the position), open interest decreases
by one.
1. Interpretation:
1. Increasing Open Interest: Indicates that new money is
flowing into the market, which can signal the continuation of
the current trend (uptrend or downtrend).
2. Decreasing Open Interest: Suggests that money is leaving
the market, which could indicate that the current trend is
losing momentum.
• Example
• Suppose there is a futures contract for oil.
• Day 1:
• Trader A buys 10 contracts from Trader B.
• Open Interest = 10 (because 10 new contracts were created).
• Day 2:
• Trader C buys 5 contracts from Trader D.
• Open Interest = 15 (because 5 more new contracts were created).
• Day 3:
• Trader A sells 5 contracts to Trader E.
• Open Interest = 15 (no change, as Trader A’s position is transferred to Trader E,
and the total number of contracts remains the same).
• Day 4:
• Trader B buys back 5 contracts from Trader A.
• Open Interest = 10 (because 5 contracts are now closed, reducing the total).

Trend Analysis: If the price of oil is rising and open interest is also increasing, it might
indicate a strong uptrend. Conversely, if the price is rising but open interest is
decreasing, it might suggest that the uptrend is losing strength, as fewer participants
are interested in holding new positions.
 FII and DII
• FII (Foreign Institutional Investor) data refers to the investment
activity of foreign entities such as hedge funds, mutual funds,
pension funds, and other large institutions in a country's financial
markets.
We look at FII data as :
1. They trade with large capital .
2. They understand market better than us.
3. They have better information and tools then us .
• When we look FII data and come to a decision we make decision
from FII point of view.
• So we can say that if call is bought then market can go up
if put is bought then market goes down
Components of FII data

Daily option activity

Daily futures activity

Change in Future OI

Options Positions as of today