What are the uses of futures and options contracts in trading?

01:57 Mins Read

Theory is one thing. Practical application is another. This video gets into the practical side of F&O trading.

Transcript

What are the uses of futures and options contracts in trading? Primarily, F&O contracts can be used for two reasons – speculative trading and hedging. What is speculative trading? In simple terms, it is the process of entering into a contract with the intention of making a profit from the change in price of a security. For instance, say you analyse various technical indicators and speculate that the price of a stock will likely go up in the coming month. So, in this case, you can purchase a call option today, so you can buy the share at a low price And possibly sell it at a higher price in the future. Okay then, what is hedging? Basically, it’s an investment strategy that is used to limit your losses if an asset loses its value over time. For example, say your purchase the shares of a company today because you’re almost entirely certain that its price will rise in the future. However, to limit your losses in case the price falls in the future, you also buy a put option today. So, in the future, if the price rises as expected, you can sell your shares and earn a profit. But if the price falls in the future, you can exercise your put option and sell your shares at the older, higher price as on the date you bought the option. So, as you can see, the main motive of speculative trading is to earn profits. But the main purpose of hedging is to limit losses. And futures and options can be used for both these purposes. To know more about how you can trade in futures, continue with the next chapter Smart Money.