Futures and options trading is in vogue, especially in India after the start of the new millennium. These comprise of the two most popular forms of derivatives instruments. A derivative is a financial instrument which drives its value from an asset, often known as the underlying. The underlying assets are as wide a category as a financial market can permit – it can range from stocks to something as unique as weather. The common forms of derivatives traded in India are stocks, market indices, commodities, currencies and so forth.
When we talk of futures, these are forward contracts which are traded in futures markets. Such contracts are formed between buyers and sellers and put on them the actual obligation to honor the contract by transacting on the asset as per the terms specified in the contract based on a price at a given date in the future. Such contracts are formed for commodities, market indices, stocks and others. Thus, if you enter into a futures contract, you agree as a buyer to buy the amount of the asset specified in the contract as per the payment terms on a future date. However, many use such contracts as speculation and make profits by short selling and other strategies within the contract period.
On the other hand, options are rights to buy or sell an underlying asset but does not impose the actual obligation to buy or sell the asset on the buyer. There are two types of options that one can purchase – call options provide one with the right to buy an asset while the put option provides one the right to sell an asset. Then again, the American style of options contracts can be executed any time within the expiry date while the European style options contract can be exercised only on the expiry date.
Futures and options trading in India occur in many ways. The Nifty and the Sensex have futures and options based on such composite stock indices at the NSE and the BSE respectively. On the other hand, there are three main commodity exchanges in the country whereby one can trade on derivatives based on commodities. Every derivatives market needs to have separate processes in place, clearing houses and other facilities to over see transactions and that is what the modern derivatives markets in India provide.
Thus, futures and options are diverse instruments for investors to consider for their portfolio.