Futures & Options (F&O) segment, also known as the derivatives market, on the stock markets has seen the fastest growing segment in the country. India's largest derivative exchange, National Stock Exchange (NSE), in the last seven years has seen its F&O segment growing more than 150 percent while the trades on the cash market have grown by 34 percent. Of the Rs. 1.04 lakh crore daily traded volumes on the NSE, close to 94 percent come from the derivative segment. Further, close to 78 percent (~Rs. 85,000 crore daily volumes) are from the option segment. On other hand, cash segment accounts six percent (~Rs. 7000 crore of the daily volumes).
This makes trading in the derivative segment, especially option segment, worth evaluating for investors. Interestingly, a large portion of the option trade is dominated by retail investors who have a view on a stock or index. Options' trading provides investors an opportunity to ride on equity movements without purchasing the underlying securities. Yet, only a small fraction of people utilize them in building their own portfolios. Many investors consider these instruments too complex and risky, which in many cases can provide a superior risk/reward ratio over simply purchasing the underlying equity. Of course, trading in the derivative segment requires some commitment in terms of time to learn how to trade and then track your trade.
As technology advances, several big broking houses have developed trading applications to help the investors to trade in the derivative markets. These applications use live robots for analytics to offer real-time market scanners to the investors and thereby eliminate tedious Excel sheet computation currently done by traders. These applications capture and process predefined market watch for Nifty, Bank Nifty, and other indices with real-time market updates with advanced technical charting support.
Is trading F&O different?
Trading in the derivative segment is very similar to trading in the cash markets but trading in F&O lets you get over the limitations of trading in the cash market. It can be used to hedge and protect your existing portfolio. It can also help you to roll-over your position up to three months. Obviously, the next question is what kind of money one can make in F&O market and what is the risk attached? If you are a buyer in the futures market, there is no limit on the profit/loss that you make. A futures contract carries unlimited profit and loss potential whereas the buyer of a Call or Put Option's loss is limited, but the profit potential is unlimited. Call writer makes money when the markets do not go up above a certain point and Put writer if market does not go down below a certain point. For beginners, it is advisable to start off buying options rather than writing/selling them. Once you get a hang of how the business works, you can look at writing/selling them as well.
Risk Associated with F&O
Ideally, F&O should not exceed more than 15 to 20 percent of your investible capital. The best way to start off trading markets is by knowing what the profitable traders are doing. It is here that new applications developed by niche broking houses come to investor's edge. Some of these applications can scan over 25,000 contracts, 5000 securities per second, and identify specific opportunities for covered calls, covered put, and long straddle with highest implied volatility. It allows investors to take calculated decisions and helps them to get options contracts filtered and listed under strategies like covered call, covered put, and long straddle with highest implied volatility.
One should definitely "Paper Trade" for a while until he gets comfortable with the process. Most brokers have "Virtual Trading" platforms that are free to use if you open an account - many do not require any deposit to use the virtual trading platform.