People are confuse about the option and future trading in stock market & which is batter for them they can”t find. this article for them to improve the knowledge and trading experience in stock market.
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Option trading and futures trading are two well-liked choices for traders when it comes to dealing on financial markets. Both are derivatives of the same underlying asset, but they vary in terms of complexity, cost, and risk. To assist you in choosing the trading option that is best for you, we will compare and contrast these two alternatives in this post.
Option Trading In Stock Market:-
Option trading is a type of derivative trading that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price and time. Options are contracts that grant the holder the right to buy or sell the underlying asset at a fixed price, known as the strike price, for a specified period, known as the expiration date. The buyer of an option pays a premium to the seller, who is obligated to honor the contract if the buyer chooses to exercise their option.
The main advantage of option trading is the limited risk involved. The maximum loss for an option buyer is limited to the premium paid, whereas the potential gain is unlimited. This makes options an attractive choice for traders who want to take advantage of market movements without risking too much capital.
On the downside, option trading can be complex and requires a thorough understanding of options pricing, greeks, and strategies. Additionally, options have an expiration date, which means that traders need to be mindful of the timing of their trades.
Futures Trading In Stock Market:-
Futures trading, on the other hand, is a contract to buy or sell an underlying asset at a predetermined price and date. Futures contracts are standardized agreements traded on exchanges, and they are often used to hedge against price movements or to speculate on the price direction of the underlying asset.
The main advantage of futures trading is the leverage it offers. Futures contracts require a smaller initial investment than the underlying asset, which means that traders can control a larger position with less capital. Additionally, futures contracts are highly liquid and can be easily traded on exchanges.
On the downside, futures trading can be more expensive than option trading due to the margin requirements and transaction costs. Futures contracts also have a higher level of risk, as the potential loss or gain is unlimited. This makes futures trading a better fit for experienced traders who are willing to accept a higher level of risk.
Difference between option and future trading:-
There are certain fundamental differences between a futures and an option contract.
| Option | Futures |
| Only the seller is obligated to perform. | Both the parties are obligated to perform. |
| Premium is paid by the buyer to the seller. | No premium is paid by any party. |
| Loss is restricted while there is unlimited gain potential for the option buyer. | There is potential/ risk for unlimited gain/loss for the futures buyer. |
| An option contract can be exercised any time during its currency by the buyer. | A futures contract has to be honored by both the parties only on the date specified. |
| Less Capital is required to trade in options. | More Capital is required to trade in futures. |
| As compared to futures trading, options trading is less risky, except when you sell options. | As compared to options trading, futures trading is more risky. |
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Black – Scholes Option Pricing Formula:-
Black – Scholes Option Pricing Formulae is based on the following assumptions:
- We are operating in a perfect market, i.e. there are no transaction costs or taxes, arbitrage opportunities do not exist, and there are no trading constraints
- Funds can be borrowed and lent at the same risk less rate of interest of interest.
- No dividends are paid on stocks
- The option would be exercised only at expiration. 5. The price changes in the stock are continuous, i.e. smooth and not bumpy.
C = SN(d_{1}) – K * e ^ (- r) * N(d*d)
The Black and Scholes formula for computing a reasonable value of an option (C) is given as follows.
Where:
c = Theoretical call premium
S=Current Stock price
t=time until option expiration K = option striking price
r=nsk-free interest rate
N = Cumulative standard normal distribution e=exponential term (2.7183)
d_{2} = d_{1} – s * sqrt(t)
s = standard deviation of stock returns
In natural logarithm
N (d1) and N (d2) represent the possibilities that deviation of less than d1 and d2 respectively will occur in a normal distribution that has a mean of 0 and a standard deviation of 1.
Factors Affecting Option Price:-
Various factors affect the price of options on stocks. We shall look at the impact of changes in ach of these factors on option prices one at a time, assuming that all other factors remain the same. There are six factors affecting the price of a stock option:
The table below shows the effect of these factors on price of a stock option (Call/Put):
| Factors | Call | Put |
| Current Stock Price | Increase in value of Stock Price results in increase in premium of call options | Increase in value Stock Price results i decrease in premium of put options. |
| Expiration Time | Far off the expiration time, higher the premium of call options | Far off the expiration time, higher the premium of put options |
| Price Volatility | Higher the price volatility of the underlying stock of the call option, higher would be the premium | Higher the price volatility of the underlying stock of the put option, higher would be the premium |
| Strike Price | As the strike price goes up, the chances of the option becoming profitable to exercise diminish and as such the premium on the option declines. | As the Strike Price As the Strike Price goes up, the chances of the put option yielding profit improve and accordingly the premium on the put option appreciates. |
| Interest Rates | Higher the interest rates, higher is the call option premium put option premium | Higher the interest rates, higher is the put option premium |
| Cash Dividends | Ex-dividend rate of the stock is usually lower than the cum dividend rate by an amount approximately equal to the cash dividend per share. the fall in the value of the stock decreases the value of the call option. | Ex- dividend rate of stock is usually lower than cum dividend rate by an amount approximately equal to the cash dividend per share. the fall in the value of the stoke increases the value of the put option. |
Conclusion:-
Two common trading alternatives offered to investors in the financial markets are option trading and futures trading. Despite the fact that they are both derivatives of the same underlying asset, they vary in terms of risk, price, and complexity. Which one to trade will depend on personal trading objectives, risk tolerance, and level of experience. It’s critical to create a unique trading plan and comprehend the advantages and disadvantages of each trading alternative. Trading futures or options may be a rewarding and successful experience if done correctly.
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