F&O stands for Futures and Options. These are types of derivative contracts that derive their value from an underlying asset, such as a stock or an index. This article explains the basics in simple language. It does not recommend any trade or strategy.
What Are Derivatives?
A derivative is a contract whose value depends on the price of something else (the underlying). The underlying can be a share, an index like Nifty 50, a commodity, or a currency. Futures and options are two common derivatives. They are used for hedging (managing risk) or speculation (taking a view on price). Both involve leverage and can lead to significant gains or losses.
What Is a Futures Contract?
A futures contract is an agreement to buy or sell the underlying at a fixed price on a future date. For example, a Nifty futures contract might obligate you to buy or sell the Nifty at a set price when the contract expires. In practice, most traders close the contract before expiry by taking an opposite position. The difference between the entry and exit price (after costs) is their profit or loss. Futures are leveraged: you put up margin (a fraction of the contract value), so gains and losses are magnified.
What Is an Options Contract?
An option gives the buyer the right, but not the obligation, to buy or sell the underlying at a specified price (strike price) on or before a specified date (expiry).
- Call option: Right to buy the underlying at the strike price.
- Put option: Right to sell the underlying at the strike price.
The buyer pays a premium to the seller. The buyer’s loss is limited to the premium paid. The seller (writer) receives the premium but can face much larger losses if the market moves against them. Options can be used in many ways (e.g. to hedge or to express a view on direction or volatility). Learning the basics of payoff and expiry is important.
Key Terms in F&O
- Underlying: The asset on which the derivative is based (e.g. a stock or Nifty).
- Expiry: The date when the contract settles or the option expires.
- Strike price: The price at which the option buyer can buy (call) or sell (put) the underlying.
- Premium: The price paid by the option buyer to the seller.
- Margin: Collateral required to hold a futures or options short position.
- Lot size: The minimum quantity (number of units) per contract; set by the exchange.
Risks in F&O
F&O trading involves leverage, so losses can exceed your initial margin or premium. Options sellers can face unlimited or large losses. Markets can gap (open far from the previous close), so stop-losses may not be executed at the price you want. Before trading F&O, you should understand the product, margin, and expiry. This article does not advise you to trade or avoid F&O; it only aims to educate.
Summary
Futures are agreements to buy or sell at a future date at a set price. Options give the right (not the obligation) to buy or sell at a strike price. Both are derivatives with leverage and significant risk. This content is for education only and is not financial advice. Always do your own research and consider professional advice.