Advantages of investing in Futures and Options

Introduction

The financial markets offer a plethora of investment options. If you want access to additional assets or markets, derivatives are a great investment option.

What are derivatives?

Derivatives are financial instruments that derive their value from underlying assets such as commodities, currencies, gold, bonds, stocks, and market indices. When you trade in derivatives, you earn by estimating the future price of the asset. Futures and Options are common derivatives in which two parties enter into an agreement to buy or sell an asset at a pre-determined price. This transaction has to be done on or before a future date.

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What are Futures?

Futures are derivative contracts in which the buyer and seller make a pact to buy or sell the underlying asset at a predetermined date and price. Also known as Futures contracts, they allow buyers and sellers to lock in the price at which the trade will be executed.

By the expiry date, the trade must be executed at the predetermined price regardless of any changes. This serves as one of the main advantages of Futures contracts. Types of Futures include Index Futures, Stock Futures, Currency Futures, Commodity Futures, and Interest Futures.

What are Options?

Options are contracts in which the buyer and seller have to execute the trade – buy or sell - in the underlying asset at a pre-determined price and date. In this case, the buyer is not obliged to execute the contract, and can allow the option to expire. However, the seller is obligated to execute the contract if the buyer decides to proceed with it. This flexibility is considered as one if the main benefits of Options contracts. There are two kinds of Options   - Call Options and Put Options.

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Derivatives are of great significance in the financial world owing to the various advantages they bring with them. These include:

Price determination

In financial markets, the direction of the asset’s price is unpredictable. Futures and Options allow buyers and sellers to decide on a specific price to trade in.

Market efficiency

Futures and Options help avoid imbalance of pricing in the market. How? The prices of these derivatives and the underlying assets tend to be in equilibrium. This helps increase efficiency in the financial markets.

Transaction costs

The cost of transacting in Futures and Options is lower as compared to the fees paid for trading shares and debentures. This reduces the transaction costs of these financial instruments.

Risk management

Since the value of Futures and Options is related to the value of the underlying asset, the contracts are used for hedging risks. That is, you can offset your losses if your contract value moves in the opposite direction.

Transferable risk

Futures and Options contracts allow investors, businesses, and municipalities to transfer the risk associated with them to other parties.

Conclusion

Trading in Futures and Options is now grabbing the attention of individual investors. At low transaction costs, you can access these financial instruments and hedge your position in the markets.

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Disclaimer

ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Centre, H. T. Parekh Marg, Churchgate, Mumbai - 400020, India, Tel No : 022 - 2288 2460, 022 - 2288 2470. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein mentioned are solely for informational and educational purpose.