Futures are Derivatives contracts in which both buyers and sellers have the obligation to buy/sell the underlying asset at a predetermined price respectively. A Futures Contract is an agreement between the buyer and the seller to buy or sell a specified quantity of the underlying asset at a future date at a price agreed upon between them. Hence, at the expiration date, the buyer must buy and the seller must sell the agreed quantity of the asset at the set price regardless of the current price of the asset. Further, these contracts are marked to market every day. In other words, the contract value is changed every day until the expiration date. They are traded on exchanges just like stocks.

Options are Derivates contracts that offer the buyer the right (but not the obligation) to buy/sell the underlying asset at a predetermined price. The buyer can also choose to allow the Option to expire. The seller has an obligation to execute the contract. They are traded on exchanges just like stocks. An Option contract has four elements:

• Strike price: This is the price at which the seller and the buyer of the Option agree to enter the Option contract.
• Premium: The buyer of an Option contract makes a payment to the seller to earn the right to an Option contract. This is called Premium.
• Expiration day: An Option contract gives the buyer the right to buy/sell the underlying asset. The Expiration Day is the last day that the owner of the Option can exercise the right.
• Lot Size: Every Options contract has a fixed number of units of the underlying asset. This is the Lot Size.

It is important to note that the buyer of an Option does not purchase the assets. Investors pay the premium amount to buy the Option and exercise their right if the market moves in their favor.

There are two types of Options contracts:

1. Call Option – Gives the owner of the Option the right to buy the underlying asset at the strike price on or before the expiration date of the contract.
   Example: Let’s say that you buy a Call Option on ABC Limited for June having a strike price of Rs.1000 and a premium of Rs.50 for a lot size of 100 shares. This means that you have the right to buy 100 shares of ABC Limited at Rs.1000 anytime until the 30th of June. To buy this right, you have to pay a premium of Rs.5000 (Rs.50 x 100 shares). On the expiration date, if the price of the share is Rs.1100, then the buyer of the Option can exercise his right to buy the shares at Rs.1000 and sell them immediately for a profit. The net earnings would be: Net Profit = Selling Price – Buying Price – Premium Net Profit = 110000 – 100000 – 5000 = Rs.5000 However, on the expiration date if the price of the shares falls to Rs.900, then the buyer of the Option can allow the contract to expire and book a loss of Rs.5000 (premium amount) as opposed to buying the shares at Rs.1000 and selling them at Rs.900 and booking a higher loss of Rs.10000. Therefore, the Call Option allows the buyer to limit losses while securing unlimited profit potential. This is a good investment avenue for investors who believe that the stock price will rise in the near future.
2. Put Option – Gives the owner of the Option the right to sell the underlying asset at the strike price on or before the expiration date of the contract.
   Example: Let’s say that you buy a Put Option on ABC Limited for June having a strike price of Rs.1000 and a premium of Rs.50 for a lot size of 100 shares. This means thatyou have the right to sell 100 shares of ABC Limited at Rs.1000 anytime until the 30th of June. To buy this right, you have to pay a premium of Rs.5000 (Rs.50 x 100 shares). On the expiration date, if the price of the share is Rs.900, then the buyer of the Option can exercise his right to buy the shares at Rs.900 and sell them immediately at Rs.1000 for a profit. The net earnings would be: Net Profit = Selling Price – Buying Price – Premium Net Profit = 100000 – 90000 – 5000 = Rs.5000 However, on the expiration date if the price of the shares climbs to Rs.1100, then the buyer of the Option can allow the contract to expire and book a loss of Rs.5000 (premium amount) as opposed to buying the shares at Rs.1100 and selling them at Rs.1000 and booking a higher loss of Rs.10000. Therefore, the Put Option allows the buyer to limit losses while securing a wide range of potential profits. This is a good investment avenue for investors who believe that the stock price will fall in the near future.