You may have heard about Futures and Options, but what do they actually mean? Simply put, they are types of derivatives.
Now, you might be wondering: What is a derivative? Let’s break it down simply.
Understanding Derivatives
A derivative is a financial product that gets its value from something else, like a stock or a commodity. Sounds tricky? Let’s make it easier.
Think of a derivative like a bonus card that gives you points based on how much you spend with your credit or debit card. The bonus card doesn’t have its own value—it depends on how much you use your card.
Similarly, a stock derivative is linked to a stock’s price. For example, if Reliance Industries’ stock price goes up, its derivative also increases in value. If the stock price goes down, the derivative’s value drops too.
Simple Examples of Derivatives
- Stock Derivative – If Reliance Industries’ stock price rises, its derivative gains value.
- Commodity Derivative – If the price of wheat increases, a wheat derivative also becomes more valuable.
- Currency Derivative – If the U.S. dollar becomes stronger, its derivative price rises.
- Index Derivative – If the Nifty index goes up, its derivative also gains value.
To put it in an even simpler way, think of me as the main source of knowledge and you as a derivative. As I learn more, you learn more too!
Types of Derivatives
There are four major types of derivatives:
- Forwards
- Futures
- Options
- Swaps
In the stock market, the most commonly used ones are Futures and Options. So, what’s the difference between them? That’s a big topic on its own! Let me know if you want to learn more about it.
Why Do People Use Derivatives?
Derivatives are used for two main reasons:
1. Speculation (Taking Risks for Profit)
Some traders buy or sell derivatives to make money based on how they think the market will move.
For example, if I believe stock prices will rise, I buy a derivative to make a profit. But if I think prices will fall, I can short sell, meaning I sell now and buy later at a lower price.
2. Hedging (Reducing Risk)
Hedging is the opposite of speculation. Instead of trying to make a profit, people use derivatives to protect themselves from losses.
For example, if I own ₹10 crores worth of stocks but think the market might crash, I can use derivatives to balance out possible losses.
Quick Comparison: Speculation vs. Hedging
| Feature | Speculation | Hedging |
| Goal | To make money | To protect money |
| Example | Guessing stock prices will rise | Protecting investments from losses |
Conclusion
This was a simple introduction to Futures and Options. Understanding F&O may seem complex at first, but with the right approach, it becomes much easier. Whether you’re looking to trade for profit or manage risk, knowing how derivatives work is essential in the stock market.