In this blog you will know about the risk management before trading futures and options?
In this blog you will know about the risk management before trading futures and options?
In the blog post we are going to discuss about the risk management strategies with the futures and options trading. When we start investing in F&Os, we should be aware that we are not going to be successful in every move; we will face some losses with some profits. But it’s not like that, it all depends how you perform, what strategies you implement, and how much experience you have trading with these derivatives. With that you must be aware of the market ups and downs and it all depends on your insights. An expert investor always know about these factors and by keeping in mind he starts to buy the share which is reliable and a excellent choice at that point of time. So keep practicing and outperform the market with your trades.
So let’s get started, now firstly we should know about what are futures & options, so that we can get clear these terms, which are the most important thing to start your trading experience.
Futures Contracts
A futures contract represents a commitment to either purchase or sell an asset at a predetermined price on a specified future date. These contracts are best grasped when applied to tangible commodities such as corn or oil. For example, a farmer might opt to secure a favorable crop price to guard against potential market declines before the crop's delivery. Similarly, the purchaser seeks to fix a price to shield against potential future price increases. For detailed understanding let’s take an example from the situation.
Imagine you've acquired a futures contract for 100 shares from XYZ Company at a price of Rs. 50 per share on a particular date. Once the contract reaches its expiration date, you'll receive these shares at the fixed amount of Rs. 50 each, disregarding the current market valuation.. Even if the current market price for each share has risen to Rs. 60, what you'll actually obtain are shares priced at Rs. 50 each.
Option Contracts
An options contract, a distinct form of derivatives contract, diverges from a futures contract in that it grants the buyer or seller the privilege to buy or sell a particular asset at an agreed-upon price on a predetermined date. Importantly, it's worth mentioning that in an options contract, there exists no requirement for the investor to execute either of these transactions (buying or selling).
They are two types
Call Options – Call options grant the buyer the right, but not the obligation, to purchase a stock, bond, commodity, or other asset or instrument at a particular price within a specific time period. If the buyer executes the call, the call seller must sell the asset.
Put Options - Put option (or "put") grants the option buyer the right, but not the duty, to sell—or sell short—a specific amount of the underlying asset at a predetermined price within a specified time period. The striking price is the predetermined price at which the buyer may sell the underlying security.
Now lets us know about the risk management while trading in futures & options (F&Os)
Risk management is an important part of futures and also alternatives trading. By correctly handling risk, investors can decrease their losses and maximize their revenues.
There are a number of threat management strategies that can be made use of in futures and options trading. Several of the most common techniques consist of:
1. Position sizing: This entails identifying the amount of cash to take the chance of on each profession. A good rule of thumb is to take the chance of no greater than 2% of your account balance on any type of single trade.
2. Stop-loss orders: These orders are placed to immediately close out a trade if the price actions versus the investor by a particular amount. Stop-loss orders can assist to restrict losses if the marketplace relocates versus the investor's position.
3. Margin needs: Futures contracts require investors to upload margin, which is a good faith deposit that is made use of to cover potential losses. The quantity of margin required differs depending on the agreement and the investor's account dimension.
4. Hedging: Hedging is a technique that includes taking a setting in a futures or alternatives contract to balance out the danger of another setting. As an example, a farmer could hedge against the threat of dropping crop prices by acquiring futures contracts on corn.
5. Spread trading: Spread trading entails at the same time dealing agreements on the very same hidden property, yet with various expiration dates or delivery months. This can aid to minimize danger by limiting the trader's exposure to price motions in a solitary contract.
Bottom-line
Whether you are an experienced investor or a beginner you must keep in mind these important strategies and you must try them while you trade. They will help you get successful trades and which entails profitable situations for investors, builds self confidence and helps you keep a track on your purchases. So in this article I have written about what are the futures and options contracts and the risk management strategies that should be practiced by the investors in order to gain more gains in a short period of time.
Article Sources - investopedia.com, motilaloswal.com, bajajfinserv.in, quora.com
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Caution: Investments in securities market are subject to market risks, read all the related documents carefully before investing.