Stock Market Learning Index
Complete guide to master stock market trading
Foundation Concepts
Stock Market Basics
What is stock market and how it works?
Market Terms
All important market terminology
Trade Types
Different types of trades
Trading Styles
Various approaches to trading
Candlestick Patterns
Bullish, Bearish & Continuation patterns
Chart Patterns
Technical chart analysis
Support & Resistance
Key price levels identification
Market Analysis
Technical, Fundamental & Price Action
Advanced Trading
Futures and Options (F&O) Guide
Comprehensive guide to understanding and trading derivatives in the stock market
Futures and options are financial instruments that belong to a class of derivatives. Derivatives derive their value from an underlying asset, like stocks, commodities, currencies, or indices. Let's break down futures and options step by step, with clear and simple examples.
Understanding Derivatives Through Examples
Definition
Those instruments which do not have their own intrinsic value and derive their value from some other thing are called derivatives.
Example 1: The Locker and Key
Suppose you have a locker which is empty - what's the value of the key? Zero.
But now suppose that locker has ₹1 Lakh in it & whoever has its key gets ₹1 Lakh. So now the key's value is also ₹1 Lakh. The key is the derivative & its underlying asset is the ₹1 Lakh inside the locker.
Example 2: The Farmer's Contract
A farmer grows potatoes currently selling for ₹10/kg, but his potatoes aren't ready yet - 3 months left for cultivation. Nobody knows the future price (last year prices fell to ₹5/kg due to oversupply).
If someone agrees to buy them at ₹10/kg even after 3 months, regardless of market price, it's profitable for the farmer. This contract signed today with delivery after 3 months is called a FORWARD CONTRACT.
Futures
Future contracts are like Forwards but with an independent third party who ensures both seller and buyer fulfill their obligations. The stock exchange acts as this third party, with regulators like SEBI ensuring fair practices.
Practical Understanding
Imagine there's land worth ₹1 Lakh, but whoever has a special token gets that land for free. That plastic token would normally cost ₹2-3, but now it derives its value from the land, making it worth ₹1 Lakh.
If the token holder gets the land after 2 months, that token is a Future for that land. You can sell that token for ₹80-90k easily since it guarantees ₹1 Lakh worth of land.
Replace LAND with MRF shares and TOKEN with MRF FUTURES. Same principle applies in the stock market.
Types of Future Tokens in Stock Market
Near Month Token
1 month timeline for delivery
Next Month Token
2 month timeline for delivery
Far Month Token
3 month timeline for delivery
Choose based on when you expect price movement - after 1, 2, or 3 months.
Why People Buy Futures
Example: MRF share is ₹1 Lakh currently. You think in 2 months it'll be ₹1.5 Lakh. Someone offers you a token at ₹1.1 Lakh - you're getting it "cheap" based on your expectation.
Risk: If after 2 months the value drops to ₹80-85k, you still pay ₹1.1 Lakh. Both profit and loss possibilities exist, same as regular stock market.
The Power of Leverage
Why not buy shares directly? The answer is LEVERAGE. You get extra buying power - can buy shares at 80-90% discounted margin.
Example: With ₹1 Lakh, you can buy only 1 MRF share. But if MRF future is in lots of 10 shares at ₹8k per lot, you can buy 1 lot (10 MRF worth) for ₹80k.
Profit Example:
Share price increases from ₹1 Lakh to ₹1.5 Lakh
Profit: ₹50k × 10 = ₹5 Lakh profit with futures vs ₹50k profit with direct stock
Loss Example:
Share price decreases from ₹1 Lakh to ₹70k
Loss: ₹30k × 10 = ₹3 Lakh loss (even though you invested only ₹80k)
Important: Brokers have the power to sell your other holdings or take strict action to recover losses. This is why people lose everything - houses, properties, bank accounts.
The volume of people buying futures is 10 times more than those buying stocks due to the leverage feature. It is both risky and profitable - it depends on how you manage it.
Warning: For someone new without other income sources, we do not recommend buying or trading futures as it can literally destroy your entire wealth. ALWAYS TRADE SAFELY WITHIN YOUR CAPACITY.
Options
The main difference between futures and options contracts is that future contracts are binding while options are not binding. With options, you have the choice to proceed with delivery or leave it.
Option trading has two types: Option Buying and Option Selling.
Understanding Options: Car Purchase Example
Scenario: You want to buy a car currently priced at ₹10 lakhs. Next month, tax rates might change. You can secure the car by paying ₹10,000 token amount.
Tax Increases Scenario
If tax increases and car becomes ₹11 lakhs, but you've booked with token, you get it for ₹10 lakhs. Profitable case.
Tax Decreases Scenario
If tax decreases and car becomes ₹9.5 lakhs, you can let the ₹10,000 token go and buy at ₹9.5 lakhs, still saving ₹40,000 overall.
This is exactly how option trading works. You pay a premium to lock in the price of a stock. Options come with specific expiry dates (weekly or monthly). If you don't exercise before expiry, it automatically settles at the last date's price.
Key Differences Summary
| Aspect | Futures | Options |
|---|---|---|
| Obligation | Binding contract - must fulfill | Right, not obligation - can choose |
| Risk | Unlimited loss potential | Limited to premium paid (for buyers) |
| Leverage | High leverage available | Leverage through premium |
| Flexibility | Less flexible | More flexible - can let expire |
Essential Trading Tips
Start Small
Begin with paper trading or small amounts to understand the mechanics
Risk Management
Never risk more than you can afford to lose completely
Education First
Understand the instruments completely before trading
Market Analysis
Use technical and fundamental analysis for better decisions
Timing Matters
Understand expiry dates and time decay effects
Professional Help
Consider consulting experienced traders or advisors