Similarities

both are traded through exchanges as a standardized contracts in terms of size, maturity and the nature of the underlying assets under stringent financial safeguards. Executions of the contracts are guaranteed by the concerned exchanges in both cases.

Differences

The significant differences in Futures and Options are as under:

• Futures are agreements/contracts to buy or sell specified quantity of the underlying assets at a price agreed upon by the buyer & seller, on or before a specified time. Both the buyer and seller are obligated to buy/sell the underlying asset. In case of options the buyer enjoys the right & not the obligation, to buy or sell the underlying asset. In case of options the buyer enjoys the right & not the obligation, to buy or sell the underlying asset.

• Futures Contracts have symmetric risk profile for both the buyer as well as the seller, whereas options have asymmetric risk profile. In case of Options, for a buyer (or holder of the option), the downside is limited to the premium (option price) he has paid while the profits may be unlimited. For a seller or writer of an option, however, the downside is unlimited while profits are limited to the premium he has received from the buyer.

• The Futures contracts prices are affected mainly by the prices of the underlying asset. The prices of options are however, affected by prices of the underlying asset, time remaining for expiry of the contract & volatility of the underlying asset.

• It costs nothing to enter into a futures contract whereas there is a cost of entering into an options contract, termed as Premium.

• The downside risks in futures are unlimited which is limited to the option premium in options. The futures contracts are supported by the initial margin an amount payable by the client as a percentage of contract value. Apart from this, if there are any changes in the futures prices on daily basis - adverse fluctuations below this initial margin - are collected from the party (mark to market). The favorable prices are credited to parry's account. In options either the underlying assets are taken as security (covered options) alternatively sufficient cash margins are kept as a measure of security.

There are two types of factors that affect the value of the option premium:

1. Quantifiable Factors:

   • underlying stock price,

   • the strike price of the option,

   • the volatility of the underlying stock,

   • the time to expiration and;

   • the risk free interest rate.

2. Non- Quantifiable Factors :

   • arket participants' varying estimates of the underlying asset's future volatility

   • Individuals' varying estimates of future performance of the underlying asset, based on fundamental or technical analysis

   • The effect of supply & demand- both in the options marketplace and in the market for the underlying asset

   • The "depth" of the market for that option - the number of transactions and the contract's trading volume on any given day.

The theoretical option pricing models are used by option traders for calculating the fair value of an option on the basis of the earlier mentioned influencing factors. An option pricing model assists the trader in keeping the prices of calls & puts in proper numerical relationship to each other & helping the trader make bids & offer quickly. The two most popular option pricing models are: Black Scholes Model which assumes that percentage change in the price of underlying follows a normal distribution. Binomial Model which assumes that percentage change in price of the underlying follows a binomial distribution.

Options Premium is not fixed by the Exchange. The fair value/ theoretical price of an option can be known with the help of pricing models & then depending on market conditions the price is determined by competitive bids & offers in the trading environment. An option's premium / price is the sum of Intrinsic value & time value (explained above). If the price of the underlying stock is held constant, the intrinsic value portion of an option premium will remain constant as well. Therefore, any change in the price of the option will be entirely due to a change in the option's time value. The time value component of the option premium can change in response to a change in the volatility of the underlying, the time to expiry, interest rate fluctuations, dividend payments & to the immediate effect of supply & demand for both the underlying & its option

The price of an Option depends on certain factors like price and volatility of the underlying, time to expiry etc. The option Greeks are the tools that measure the sensitivity of the option price to the above mentioned factors. They are often used by professional traders for trading & managing the risk of large positions in options & stocks. These Option Greeks are:

• Delta: is the option Greek that measures the estimated change in option premium/price for a change in the price of the underlying.

• Gamma: measures the estimated change in the Delta of an option for a change in the price of the underlying

• Vega: measures the estimated change in the option price for a change in the volatility of the underlying.

• Theta: measures the estimated change in the option price for a change in the time to option expiry.

• Rho: measures the estimated change in the option price for a change in the risk free interest rates.

An option calculator is a tool to calculate the price of an Option on the basis of various influencing factors like the price of the underlying and its volatility, time to expiry, risk free interest rate etc. It also helps the user to understand how a change in any one of the factors or more, will affect the option price

Options are an important element of investing in markets, serving a function of managing risk and generating income. Unlike most other types of investments today, options provide a unique set of benefits. Not only does option trading provide a cheap and effective means of hedging one's portfolio against adverse and unexpected price fluctuations, but it also offers a tremendous speculative dimension to trading.

One of the primary advantages of option trading is that option contracts enable a trade to be leveraged, allowing the trader to control the full value of an asset for a fraction of the actual cost. And since an option's price mirrors that of the underlying asset at the very least, any favorable return in the asset will be met with a greater percentage return. Option provides limited risk and unlimited reward.

With options, the buyer can only lose what was paid for the option contract, which is a fraction of what the actual cost of the asset would be. However, the profit potential is unlimited because the option holder possesses a contract that performs parallelly with the asset itself. If the outlook is positive for the security, so too will the outlook be for that asset's underlying options. Options also provide their owners with numerous trading alternatives. Options can be customized and combined with other options and even other investments to take advantage of any possible price dislocation within the market. They enable the trader or investor to acquire a position that is appropriate for any type of market outlook that he or she may have, be it bullish, bearish, choppy, or silent.

Buying options can therefore be compared to buying insurance. For example to cover the risk of burglary, fire, etc. you buy insurance and pay premium. In the event of any untoward happening, the insurance cover compensates you for the losses. Otherwise, the insurance cover expires after the specific period of time. The insurance premium is the cost for the cover. Similarly, in the case of options, the right to buy or sell the underlying is acquired by payment of a premium. This affords protection against a general fall in market and thus can be attractive to various investors including Mutual Funds, who may like to bundle Nifty funds with Nifty options. The option could be exercised in the event of adverse market movement. Otherwise, the option will expire after the specific period. The cost of the option, i.e. the premium, is paid at the time of purchase. There is no further loss that is generated by the option for the buyer. This feature of option makes it attractive for the market participants.

One can protect his equity portfolio from a decline in the market by way of buying a protective put wherein one buys puts against an existing stock position This option position can supply the insurance needed to overcome the uncertainty of the marketplace. Hence, by paying a relatively small premium (compared to the market value of the stock), an investor knows that no matter how far the stock drops, it can be sold at the strike price of the Put anytime until the Put expires. E.g. An investor holding 1 share of Infosys at a market price of Rs 5000/-thinks that the stock is over-valued and therefore decides to buy a Put option' at a strike price of Rs. 4000/- by paying a premium of Rs 200/- If the market price of Infosys comes down to Rs 4000/-, he can still sell it at Rs 4000/- by exercising his put option. Thus by paying a premium of Rs. 200, he insured his position in the underlying stock.

If you anticipate a certain directional movement in the price of a stock, the right to buy or sell that stock at a predetermined price, for a specific duration of time can offer an attractive investment opportunity. The decision as to what type of option to buy is dependent on whether your outlook for the respective security is positive (bullish) or negative (bearish). If your outlook is positive, buying a call option creates the opportunity to share in the upside potential of a stock without having to risk more than a fraction of its market value (premium paid). Conversely, if you anticipate downward movement, buying a put option will enable you to protect against downside risk without limiting profit potential. Purchasing options offer you the ability to position yourself accordingly with your market expectations in a manner such that you can both profit and protect with limited risk.

Option is a contract which has a market value like any other tradable commodity. Once an option is bought there are following alternatives that an option holder has:

• You can sell an option of the same series as the one you had bought & close out /square off your position in that option at any time on or before the expiration.

• You can exercise the option on the expiration day in case of European Option or; on or before the expiration day in case of an American option. In case the option is 'Out of Money' at the time of expiry, it will expire worthless.

Like stocks, options and futures contracts are also traded on any exchange. In Bombay Stock Exchange, stocks are traded on BSE On Line Trading (BOLT) system and options and futures are traded on Derivatives Trading and Settlement System (DTSS). In NSC options & futures are trade in F & O Segment (Futures & Options Segment) & Stocks in the Capital Market Segment. NSE started trading in the equities segment (Capital Market segment) on November 3, 1994. Options trading started in June 2001.

An investor has to register himself with a broker who is a member of the NSE F & O Segment or BSE Derivatives Segment. If he wants to buy an option, he can place the order for buying a Sensex/Nifty Call or Put option with the broker. The Premium has to be paid up-front in cash. He can either hold on to the contract till its expiry or square up his position by entering into a reverse trade. If he closes out his position, he will receive Premium in cash, the next day. If the investor holds the position till expiry day and decides to exercise the contract, he will receive the difference between Option Settlement price & the Strike price in cash. If he does not exercise his option, it will expire worthless. If an investor wants to write/ sell an option, he will place an order for selling Nifty/Sensex Call/ Put option. Initial margin based on his position will have to be paid up-front (adjusted from the collateral deposited with his broker) and he will receive the premium in cash, the next day. Everyday his position will be marked to market & variance margin will have to be paid. He can close out his position by a buying the option by paying requisite premium. The initial margin which he had paid on the first position will be refunded. If he waits till expiry, and the option is exercised, he will have to pay the difference in the Strike price & the options settlement price, in cash. If the option is not exercised, the investor will not have to pay anything.