Aug 08, 2014,17.17 IST

All you want to know about Future & Options

1. What is margin?

It is a security deposit given by trading members to the exchange in order to deal in different types of securities listed on the exchange. The members are required to maintain an appropriate margin (amount of money to keep trading) account with a clearing house

2. What are the types of margins?

a) Initial or maintenance margin: In order to trade in futures market you need to deposit certain sum of money with the clearing house before entering into trade. The initial margin must be maintained throughout the time that position is open. It is refundable at the time of expiry and delivery, depending on the profit and loss on trade.
b) Mark -to-market margin: Mark-to-market occurs on daily basis i.e. it is calculated on each trading day by taking the difference between closing price of a contract and the price at which the trading was done. Investor marks to market a security to ensure margin account is having its minimum maintenance.
c) Special margin – Special margin is levied to control excessive speculation and to protect the interest of common traders and investors. When there is a continuous one-sided price movement i.e. continuous rise or fall then extra margin is charged to traders having an open position.

3. What are different types of orders?

The orders are divided in two types
Price related order
a) Limit order: It is that order at which buying and selling is done at a specific price. For a buyer, generally a limit order is lower and for a seller, the limit order is higher.
b) Market order: Market order is placed by the buyer and seller at the current market price. However, market order cannot specify the actual price of shares as the actual price of the order will be unknown unless the order is executed.
c) Stop loss order: Stop loss order is placed after entering into the trade.  A stop loss order will pre-determine the maximum loss that a trader will incur. It is helpful at the time of high volatility to mitigate the risk of unlimited loss.
d) Trailing stop loss: Trailing stop loss helps the trader to increase his profit. An effective use of trailing stop loss can help you make money during market volatility. However, trailing stop loss should only be used when the trade is in profit.

Time related orders
a) Day order: These orders are to be executed on the same trading day that they are entered. If they are not executed on the same day then they are automatically cancelled by the exchange.
b) Good-till-date order: It specifies a particular date till which the order will remain alive for execution.
c) Good-till-cancelled order: This order remains in the system until execution or till the time it is cancelled, whichever is earlier.

4. What is a meaning of basis?

Basis is a difference between the spot price of an asset and the future price of the same asset.

5. What is bid/ask price?

The highest price that a buyer is willing to pay is called as bid price. The price at which the seller is willing to accept it is called as ask price. When bid price of the buyer matches with the ask price of seller then a trade takes place.
 
6. What is entry/exit?

The initiation of a trade either by buying or selling is called entry or entering into trade. After entry, it is said to be an open position and closing the open position is termed as exit or square off.

7. What are derivatives?

Derivatives are instruments used to hedge risk but can also be used as speculation tool. It is a kind of security or financial contract and its value is derived from one or more underlying assets such as stocks, commodities, bonds, interest rates and currencies. Hedgers face a risk associated with price of an asset, while speculators bet on the future movements in price of stock.

8. What is a future contract?

Future contract is a kind of derivative contract in which a stock is bought or sold at a specific price on a specific date in future i.e pre- determined price in future. For example: A enters in a contract with B to buy certain number of bushels of wheat at a particular time and price in future then the contract must be honoured on the decided time and price whether at that time price of wheat is up or down. In this case, either of the two will make profit. The future contract reduces volatility but carries risk.

9. What are options?

An option is a contract that gives buyer a right, but not obligation to buy or sell the shares of underlying security. The option contract is between two parties under which buyer receives a privilege (right) for which he will pay premium (price buyer pay) and seller accepts an obligation for which he receives a fee from buyer.

10. What is short selling?

Short selling is selling a stock that a seller does not own at the time of trade. For example: If you hear that there has been a bumper crop of sugar in Brazil and other sugar producing countries and you assume that price of sugar will fall in India as reaction to this news you can take advantage and sell futures contract (which you do not own) at the price prevailing in futures market. Short selling involves high risk reward ratio and should only be executed strictly by professionals.

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