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Insights: Weekly Q&A For Stock Market Newbies”, to spread the basic stock market knowledge to the beginners.
This is your go-to resource for demystifying the stock market from the
scratch. Each day, we will present 10 carefully curated questions with answers
that will cover essential concepts, strategies, and terminologies. Whether you
have just entered into the market, or trying to starting your stock market
journey, or looking to strengthen your foundation, our weekly post will guide
you through the basics and beyond, making investing accessible and understandable
for everyone. Happy reading.
Day 23: Basic Stock Market Concepts
Fundamentals of Futures and Options
Trading:
1. What is Futures Contract?
A futures
contract is a standardized agreement to buy or sell an asset at a predetermined
price on a specified future date.
A futures
contract consists of the underlying asset, the contract size, the expiration
date, the futures price, and the margin requirements. The underlying asset can
be a commodity, currency, or financial instrument.
Futures
are also used to hedge the price movement of an asset to restrict losses from unfavourable
price movements.
2. What is Leverage in Futures Trading?
Leverage
in futures trading refers to using borrowed funds to increase the size of a
position. Traders only need to put down a margin, which is a fraction of the
total contract value, allowing them to access
larger
portion of amounts of the underlying asset.
Leverage
may increase the profits and losses, so it is important to use leverage
managing risks skillfully. There are different stages of leverages, such as
initial margin, magnified returns, magnified losses, calculating
leverage.
3. What is the Role of Margin in Futures Trading?
Margin is
the initial deposit a trader deposits with his broker which is required to
enter a futures position. It acts as collateral to ensure that the trader can
cover potential losses. If the position moves unfavorably, a margin call may
require the trader to add more funds. Margin is a kind of leverage that allows
traders to pay less than the total value of a contract. It can increase the
profit potential as well as losses.
Some key
components of margin are initial margin, maintenance margin, margin call,
overnight margin, day trading margin, mark to market.
4. What are Futures
Rollover?
A futures rollover occurs when a trader closes their current futures
contract and opens a new one with a later expiration date. Rollovers are common
when traders want to maintain a position beyond the current contract’s
expiration, allowing them to maintain their current position without
disturbance and avoiding the costs and obligations of settlement.
Traders use rollovers to keep their market view intact, to profit from
the price movement after the expiry of the contract, or maintain the same risk
position beyond the initial expiry of the contract.
5. Define Types of Options
There are two types of options: American style options and European
style options. In American style options the buyer of the option can choose to
exercise his option only at any given time period between the purchase
date and the expiry date.
In European style options the buyer of the option can only choose to
exercise his option on the expiry date.
NSE options are European style options. The premium paid to buy an
American style option is normally equal to or greater than the European style
option for the same underlying.
6. What are the
Factors that Influence the Options Premium?
Options premium is influenced by the following factors;
A) Intrinsic Value:
The difference between the current value of the underlying asset and the strike
price of the option.
B) Time Value:
The longer the time until expiration, the higher the premium, as there
is more time for the option to become profitable.
C) Volatility:
Higher volatility in the underlying asset increases the option's premium
since there is a greater chance of significant price movement.
D) Interest Rates:
Higher interest rates can also impact the option’s premium, particularly
for long-term options.
7. Explain option
moneyless (ITM, ATM, OTM).
Call Option:
In the money (ITM): The market price
of the underlying asset is more than the strike price.
At the money (ATM): The market price of
the underlying asset is the same as the strike price
Out of the money
(OTM): The market price of the underlying asset is less than the strike
price.
Put Option:
In the money (ITM): The market price
of the underlying asset is less than the strike price.
At the money (ATM): The market price
of the underlying asset is the same as the strike price.
Out of the money
(ITM): The market price of the underlying asset is more than the strike
price.
8. What is
Volatility in Options Trading?
Volatility refers to the degree of price fluctuations in the underlying
asset. In options trading, higher volatility generally increases the option
premium, as it indicates a greater likelihood of the price moving in favourable
direction for the option holder.
9. What is Implied
Volatility in Options?
Implied volatility is a measure of the market’s expectations for the
future volatility of the underlying asset. High implied volatility suggests
that the market expects significant price fluctuations, which increases option
premiums.
10. What is an
option chain in options?
An options chain is a listing of all available options for a given
underlying asset, shown in columns, showing various strike prices, expiration
dates, and premiums for both call and put options. Traders use the options
chain to choose contracts that fit their market outlook and strategy.
If you have any other questions in your mind relating to stock market basics or need any clarification, please put your query into the comment box, We will try our best to clarify the same
Disclaimer: The information provided on MoneyWiseMind is for educational and informational purposes only. It is not intended to be financial advice, and you should not rely on it as such. Before making any financial decisions, you should consult a licensed financial advisor.
