What is Future an options in stock market?

Answer 1

You are confusing a few different financial terms.

There are Stocks, Options and Futures.

Stocks & Futures both have options attached to them.

Options are a derivative.

See related links for more about stock options and how they work.

Answer 2

Futures Contract: A futures contract is an agreement to buy or sell an asset at a certain time in the future at a specific price. The Contractual terms of the futures contracts are very clear. The Futures market was designed to solve the shortcomings in the forwards contracts. Unlike forwards, futures are traded in organized exchanges. They also use a clearing house that provides the necessary protection to both the buyer and the seller. The price of the futures contract can change prior to delivery. Hence, both participants must settle daily price changes as per the contract values. An Example of a futures contract would be an agreement to 100 tonnes of Steel at Rs. 10000/- per tonne at some date say in December 2008. If no interim payments are made and if the price of Steel moves violently, a considerable credit risk could build up. To avoid this a margin system is used by the exchanges. As per the margin system, both parties must deposit a small sum with the exchange. This amount will be a small percentage of the total contract. This amount is called the initial margin. As the steel value changes, the contract value also changes. If the contract value changes, the margin must be topped up by an amount corresponding to the change in price of steel. The margin money is the property of the person who deposits it and would be returned to them if the contract gets cancelled/completed. Characteristics of Futures contract: 1. They are traded in organized exchanges 2. Credit risk is eliminated with the margin system. Both parties deposit a portion of the contract with the clearing house. 3. Both the buyer and seller are bound by the contract terms and are expected to honour their end of the contract. Options Contract: An options contract is nothing but the right to buy or sell something at a specified price within a period of time. The feature of the options contract for a buyer is that, the buyer has the right to buy, but he may choose to buy or may even choose to cancel the contract. Hence the buyers maximum loss is only the initial amount that was paid to gain the rights. Unlike buyers, the options contracts for sellers is an obligation. If a seller enters into an agreement, he has to deliver the asset on the specified date and the price agreed upon. Thus the loss for a seller could be much worse. The right to buy is called a "CALL" option while the right to sell is called a "PUT" option. Please note that an option is only a right to do something. It is not an obligation to carry out the action. For a buyer it is only a right and not an obligation, but for a seller it is an obligation. For Example, you want to buy Gold. You form an options contract with a Gold merchant to buy 1000 grams of Gold at the rate of say Rs. 1000/- per gram of gold on December 1st 2008. The total value of the contract would sum up to 10,00,000/- (10 lacs) As part of getting into the contract you make an initial payment of say 2% of the contract value to the merchant. You make a payment of Rs. 20 thousand (Rs. 20,000/-) and the contract gets formed. Now you are the buyer and the merchant is the seller. Now there could two possible scenarios: 1. Assuming on 1st December the price of gold is Rs. 1050/- per gram, then to buy thousand grams of gold you would need Rs. 10,50,000/- rupees which is Rs. 50,000/- more than your options contract. Hence if you exercise your right to buy, you stand to make a profit of Rs. 50,000/- At the same time, the seller has an obligation since he has agreed on the contract and he has to sell the gold to you at a loss of Rs. 50,000/- when compared to the market rate. 2. Assuming on 1st December the price of gold is Rs. 950/- per gram, then to buy thousand grams of gold you would need Rs. 9,50,000/- which is Rs. 50,000/- less than your options contract. Hence if you exercise your right to buy, you stand to lose Rs. 50,000/- You can buy the same quantity of gold in the market at a lesser price. Hence you can choose to let your contract expire and limit your losses to only Rs. 20,000/- The Seller on the other hand does not make any transaction but still stands to keep the Rs. 20,000/- you paid him to form the contract. This 1000 rupees per gram that you agreed upon with the merchant is called the "Strike" Price. The initial deposit of Rs. 20,000/- you paid him is called the "Option premium". Partcipants in an Options market: 1. Buyers of Calls 2. Sellers of Calls 3. Buyers of Puts 4. Sellers of Puts People who buy options are called "Holders" and those who sell options are called "Writers" Call Holders and Put Holders (The Buyers) are not obligated to buy or sell. They have the right to do so if they wish. Similarly Call writers and Put Writers (The Sellers) are obliged to buy or sell. This means that they need to buy or sell if the Call holder decides to exercise his right to buy. Characteristics of Options Contracts: 1. Unlike other derivative products that are price fixing contracts, options are price insurance type of contracts 2. Options have been basically OTC products. But of late, due to its popularity, exchange traded options are also being widely used. 3. The options are very favourable to the Holders or the Buyers. Widely used terms in Options contracts: In-the-Money - An ITM option is one that would lead to a positive cash flow to the holder if it were exercised immediately. For e.g., If you have an options contract to buy shares of XYZ limited at Rs. 100/- per share and it is currently trading at Rs. 120/- per share then your options contract is said to be In the Money. At-the-Money - An ATM option is when the prevailing price of the asset and your option price are more or less same. Out-of-the-Money - An OTM option is when the prevailing price of the asset is lesser than the option price.