What are the advantages of Futures/Options versus Cash?

leo_3455 · #1 28th December 2007, 05:39 PM

Hello All:

What are the advantages/disadvantages of Futures/Options versus Cash? Which one of the derivatives (Futures or Options) is better for short term/long term investors and day traders?

What is the difference between buying 2000 shares in cash market versus buying a lot of 2000 shares in Futures and Options?

Thanks

djsinha · #2 29th December 2007, 07:02 AM

Quote:

Originally Posted by leo_3455

Hello All:

What are the advantages/disadvantages of Futures/Options versus Cash? Which one of the derivatives (Futures or Options) is better for short term/long term investors and day traders?

What is the difference between buying 2000 shares in cash market versus buying a lot of 2000 shares in Futures and Options?

Thanks

In options/ futures gains are bigger.
Say, u bought 2000 shares of reliance at CMP of 2000. Your total invested capital = 2,000*2,000=40,00,000.(Note u have to have 40 lacs in ur demat acc at the time of making this investment)
Now say when u sell reliance shares, it has appreciated to 2200. Then ur total profit = (2200-2000)*2000=4,00,000 on an investment of 40 lakhs.
So, profit % = 4 lacs / 40 lacs *100 = 10%

Now, considering the same in futures/ options mkt:
Say reliance shares are avalaible at a lot of 1000 shares. U buy 40,000 1 month CALL option of ril at say a strike price of 2100 @ Rs 100 premium. Pls note that at the time when u enter this contract u need to have (premium * no of contracts) i.e. in this case, 100*40000(=Rs 40,00,000) in ur acc. So in F&O with the same amt of money ur purchasing power increases manifold.
Now lets consider, after u made all these buying, the price of RIL heads northwards. It crosses 2200 after 10 days. From 2200 onwards u'll start making profit although ur purchasing price was 2100. This is bcoz ur effective purchasing price will become ur actual strike price+premium. That's 2100+100 = 2200. Say, at the end of the month the price went to 2300. Then ur total profit will be Rs 1,000*40,000*100 = 40,00,000. And ur investment was 40 lacs. So ur profit % = 100%.

So ur profit % will always be greater in F&O then in equities if u risk the same amt.

Hope this clears ur doubt.

leo_3455 · #3 29th December 2007, 10:30 AM

I appreciate you taking time to reply my query. I have done trades in Cash markets and want to learn Futures/Options before trying it out in 2008.

Supplementary to the above; I get one lot (550 shares) of Reliance Energy "OPT-BSES-31-Jan-2008-2040-CA" at a premium of 217.10, strike price 2040 when the spot price is 2150.10. What is the minimum balance required to buy this contract. Is the proceedings profit/loss credited/debited at the end of the day daily?

Now what do we have to track: Spot price or the premium for the strike price of 2040. Does the strike price change for 31-Jan-2008 for this option?

How do we calculate how much profit/loss we make at the end of the day? What if we don't exercise our option on or before 31-Jan-2008?

Also there are many options available with different strike price and different premiums. For a Call option, do we need to choose the strike price nearer to Spot Price?

Thanks for your reply djsinha.

NILKANTH KORANNE · #4 29th December 2007, 06:57 PM

This is the best thread I came across. All Pundits are requested to contribute so that newcomers will be benefitted.

soody · #5 29th December 2007, 07:45 PM

If u have big money cash is always best, FnO is very risky game( takes a lot of time to master this). If u look at the Open interest in previous expiry Options segment huge losses to FnO traders in scrips like IFCI,NTPC etc etc.
In cash u never lose the game, Hold it and U will always win.

Laksh · #6 29th December 2007, 08:16 PM

Quote:

Originally Posted by leo_3455

Hello All:

What are the advantages/disadvantages of Futures/Options versus Cash? Which one of the derivatives (Futures or Options) is better for short term/long term investors and day traders?

What is the difference between buying 2000 shares in cash market versus buying a lot of 2000 shares in Futures and Options?

Thanks

The main advantage of futures is you get a lot of leverage. But leverage is a double edged sword. It multiplies your profit as well as your loss. Unless you are very proficient in risk control and trading you can accumulate huge losses in very little time - even you can blow up your account. In cash you can control your risk by position sizing as the lot size is only 1 share. In futures the lot size is about Rs.2 lakhs- many scrips have a much higher lot size because of price appreciation. Because of this you cannot adjust the risk to your liking by position sizing unless you have quite a substantial amount of trading capital.Moreover, you can hold your cash shares indefinitely; but you have to settle your futures trade on the last Thursday of the month and accept profit/loss-if any.

The lot size of options are the same as that of futures; but there are some mitigating factors provided you know the various option strategies - which are many in number and require a lot of study and practice. For buying option you have to have the money to pay the premium plus brokerage; but for selling option you require substantial margin. The strike price remains fixed till the end of the settlement but the premium keeps on changing. The profit/loss in buying option is the difference of your purchase price and the current premium. Yes the profit/loss is credited/debited to your account daily at the closing price but you receive it only after closing your open position. One main disadvantage of buying option is its time value which is a wasting asset and the wasting occurs faster as it approaches settlement day.

I suggest you buy a book on the subject and do some study, paper trading before venturing into trading futures and options with your cash.

Laksh