APPLICATIONS OF FUTURES AND OPTIONS
The phenomenal growth of financial derivatives across the world is attributed the fulfilment of needs of hedgers, speculators and arbitraguers by these products. In this chapter we first look at how trading futures differs from trading the underlying spot. We then look at the payoff of these contracts, and finally at how these contracts can be used by various entities in the economy.
A Pay off is likely profit or loss that would accrue to a market participant with change in the price of the underlying asset.
TRADING UNDERLYING VERSUS TRADING SINGLE STOCK FUTURES
The single stock futures market in India has been a great success story across the world. nse india ranks first in the world in terms of number of contracts traded in single stock futures. One of the reasons for the success could be the ease of trading and online trading tips settling these contracts.
To trade securities, a customer must open a security trading account with a securities broker and a demat account with a securities depository. Buying security involves putting up all the money upfront. With the purchase of shares of a company, the holder becomes a part owner of the free trading tips. The shareholder typically receives the rights and privileges associated with the security, which may include the receipt of dividends, invitation to the annual share holders meeting and the power to vote.
Selling securities involves buying the security before selling it. Even in cases where short selling is permitted, it is assumed that the securities broker owns the security and then lends it to the trader so that he can sell it. Besides, even if permitted, short sales on security can only be executed on an up-tick nse stock market.
To trade futures, a customer must open a futures trading account with a derivatives broker. Buying futures simply involves putting in the margin money. They enable the futures traders to take a position in the underlying security without having to open an accouont with a securities broker. With the purchase of futures on a security, the holder essentially makes a legally binding promise or obligation to buy the underlying security at some point in the future (the expiration date of the contract). Security futures do not represent ownership in a corporation and the holder is therefore not regarded as a shareholder.
A futures contract represents a promise to transact at some point in the future. In this light, a promise to sell security is just as easy to make as a promise to buy security. Selling security futures without previously owning them simply obligates the trader to selling a certain amount of the underlying security at some point in the future. It can be done just as easily as buying futures, which obligates the trader to buying a certain amount of the option trading courses underlying security at some pint tin the future. In the following sections we shall look at some uses of security future.
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