Futures And Options

FUTURES AND OPTIONS

An interesting question to ask at this stage is, when would one use options instead of futures? Options are different from futures in several interesting senses. At a practical level, the option buyer faces an interesting situation. He pays for the option in full at the time it is purchased. After this, he only has an upside. There is no possibility of the options position generating any further losses to him (other than the funds already paid for the option). This is different from futures, which is free to enter into, but can generate very large losses. This characteristic makes options attractive to many occasional market participants, who cannot put in the time to closely monitor their futures positions.

Buying put options is buying insurance. To buy put option on Nifty is to buy insurance which reimburses the full extent to Which Nifty drops below the strike price of put option. This is attractive to many people, and to mutual funds creating “guaranteed returned profits”. The Nifty index fund industry will find it very useful to make a bundle of a Nifty index fund and a Nifty put option to create a new kind of a Nifty index fund, which gives the investor protection against extreme drops in Nifty. Selling put options is selling insurance, so anyone who feels like earning revenues by selling insurance can set himself up to do so on the index options market.

More generally, options offer “nonlinear payoffs” whereas futures only have “linear payoffs”. By combining futures and options, a wide variety of innovative and useful payoff structures can be created.

 

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