Futures and options trading in India are both derivative instruments, meaning their value is derived from an underlying asset or instrument. Futures and options both have advantages and disadvantages. This article will list out the advantages of both the derivative instruments.
Advantages of Futures:
Futures are not the best way to trade stocks, but they are an excellent way to trade specific investments such as commodities, currencies, and indexes. Their standardized features and extremely high levels of leverage make them especially appealing to the risk-averse retail investor. Because of the high leverage, those investors are able to participate in markets to which they would not have otherwise had access.
Fixed Trading Cost:
The margin requirements for major commodity and currency futures are well known because they have remained relatively constant for many years. Margin requirements may be temporarily increased when an asset is particularly volatile, but they are usually unchanged from year to year. This means that a trader knows ahead of time how much initial margin is required. The option premium paid by an option buyer, on the other hand, can vary significantly depending on the volatility of the underlying asset and the overall market. The higher the premium paid by the option buyer, the more volatile the underlying or the broad market.
No time lapse:
Futures Trading in India have a significant advantage over options in this regard. Options are wasting assets, which means that their value depreciates over time—a phenomenon known as time decay. The time to expiration is one of the most important factors influencing an option’s time decay. Time decay must be considered by an options trader because it can severely erode the profitability of an option position or turn a winning position into a losing one. Futures, on the other hand, are not affected by time decay.
This is yet another significant advantage of futures over options. Most futures markets are extremely deep and liquid, particularly in commodities, currencies, and indexes that are widely traded. This causes bid-ask spreads to narrow and reassures traders that they can enter and exit positions as needed. Options, on the other hand, may not always have enough liquidity, particularly if they are far from the strike price or expire far in the future.
Pricing is straightforward:
Futures pricing is intuitively simple to grasp. The futures price should be the same as the current spot price plus the cost of carrying (or storing) the underlying asset until the futures contract matures, according to the cost-of-carry pricing model. If the spot and futures prices are not in sync, arbitrage activity will take place to correct the imbalance. Option pricing, on the other hand, is typically based on the Black-Scholes model, which employs a number of inputs and is notoriously difficult for the average investor to grasp.
Advantages of Options:
Options Trading in India have a lot of leverage. As a result, an investor can obtain an option position that is similar to a stock position, but at a much lower cost. Assume you want to buy XYZ Corp. stock. You want to buy 200 shares of XYZ at Rs 130 each, which will cost you Rs 26,000 in total. Instead of putting up that much money, you could have gone to the options market, selected an option that closely matched the stock, and purchased the August call option with a strike price of Rs 100 for Rs 36. To obtain a position the size of the 200 shares mentioned above, you would need to purchase two contracts. This reduces your total investment to Rs 7,200 as opposed to Rs 26,000 previously.
Buying options can be riskier than owning equities in some situations, but options can also be used to reduce risk. It all depends on how you intend to use them. Options can be less risky for investors because they require less financial commitment than equities, and they can also be less risky due to their relative invulnerability to the potentially disastrous effects of gap openings.
Increased Potential Returns:
You don’t need to be a math’s wizard to figure out that if you spend less money and make nearly the same profit, your percentage return will be higher. That is what options typically offer to investors when they pay off.
Alternatives that are more strategic:
The final significant advantage of options is that they provide more investment options. Options are a highly adaptable tool. There are numerous methods for re-creating other positions using options. These are referred to as synthetic positions. Synthetic positions provide investors with multiple ways to achieve the same investment objectives, which can be very beneficial.
As we have discussed the benefits of both Futures and Options, it’s upon you as an investor to select the instrument that suits the best for you. Also, diversification of portfolio is one of the main winning strategies and investing in both will help you achieve it. No matter if you are investing in either one of them or both, we at Tradeplus will provide you with our valuable services to make the entire investment process simple.