As a new trader I’m not able to understand why, in F&O Tracker, you advise to buy call options as an alternative to buying futures. Please explain why – Nagendra Kumar Goyal

Risk and margin obligation are the key factors that one should consider in deciding between futures and options. Let’s see with an example. Suppose you are bullish on Nifty 50, you can capitalise on this potential rally either by going long on Nifty futures or by buying Nifty options.

When it comes to Nifty futures, the margin requirement, just for initiating the trade, would be around ₹70,000 at the current market price. In addition to this, you should have margin for possible mark-to-market losses, say ₹50,000. So, for buying one lot of Nifty futures, you will require around ₹1.2 lakh.

Alternatively, you can buy a Nifty call option. Suppose you are buying at-the-money call, which now is 23,300. The premium of 23,300-strike call of June monthly expiry is now around ₹300 per lot. Multiplying it by the lot size of Nifty, which is 25, means, you would require only ₹7,500.

Now coming to the risk. In case Nifty futures drop 200 points after you go long. Then the loss in your long position on Nifty futures would be ₹5,000 (200 multiplied by lot size of 25). Note that 200 points move in your direction means a profit of ₹5,000. Because Nifty futures will mostly make like-for-like movements when compared to Nifty 50.

For the same 200-point fall in Nifty 50, the premium of 23300-strike call option will drop to ₹200. Therefore, your loss will be around ₹2,500 (difference in premium i.e., ₹300 minus ₹200 multiplied by lot size of 25). If Nifty 50 rallies 200 points, the premium of this option will rise to ₹440. Hence, your profits will be ₹3,500 (difference in premium i.e., ₹440 minus ₹300 multiplied by lot size of 25).

So, you can see that for the same move in Nifty 50, both risk and reward is relatively higher in futures when compared to options.

The key difference between futures and options with the respect to risk is the maximum loss. In option buying, the premium that you pay is the maximum loss (the opposite is true for option selling. So, new traders are not advised to resort to option selling). Whereas in futures, the loss keeps on increasing as long as the contract moves in the opposite direction of your trade.

Considering the above, option buying may appear attractive. However, the catch is time decay. Option loses its value as time passes even if the underlying asset stays flat. But futures do not have this risk.

Send your queries to derivatives@thehindu.co.in

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