Derivatives are unique financial instruments that derive their value from the value of an underlying asset. There are two primary derivative instruments that you can trade in the Indian stock market - futures and options. Investors often use derivatives to hedge their investment risk in an underlying asset. However, trading in derivatives is also a good way to generate profits through price speculation.
As far as derivative contracts are concerned, there are four different types - forward contracts, futures contracts, options contracts and swaps. In India, however, the most commonly traded derivative contracts are futures and options.
The primary participants of the derivative market include retail traders, large institutional traders, stockbrokers, clearinghouses and stock exchanges.
The margin requirements for derivative contracts are dependent on a multitude of different factors. The underlying asset, its current market value, lot size, number of lots, type of trade, implied market volatility and time until contract expiry are a few of the factors that determine the amount of margin you need to deposit to trade in a derivative contract.
Some of the common types of futures contracts that are available for trade include equity futures, index futures, interest rate futures, currency futures, commodity futures, and volatility futures.
Both forward contracts and futures contracts have the same objective - to purchase or sell an asset at a specific price on a particular future date. Despite their common objective, there are a few crucial differences between these two contracts. Firstly, forward contracts are usually entered into by two or more parties who are acquainted with each other. In future contracts, however, there are only two parties whose identities are often unknown to each other. Secondly, future contracts are traded on exchanges, whereas forward contracts are not. And finally, future contracts are standardized and heavily regulated by multiple participants, whereas forward contracts are customized and unregulated.
The trading hours for the equity and index derivative markets start at 9.15 AM and come to a close at 3.30 PM. The trading hours for the currency and interest rate derivative market, however, start at 9.00 AM and close at 5.00 PM. As for the commodity derivative market, the trading hours start at 9.00 AM and close at 11.30 PM.
Futures and options are derivative contracts traded on exchanges. Futures obligate buyers to purchase and sellers to sell the underlying asset at a specific price on a predetermined date. Options, on the other hand, give the purchaser the right but not the requirement or obligation to buy (in the case of call options) or sell (in the case of put options) the underlying asset at the strike price on expiry.
F&O trading can be profitable if you utilise the right strategies. However, it can also be risky. If the market moves favourably, the profits can be substantial because of leverage, which allows you to control large positions with less capital. However, losses can also be significant if the market moves unexpectedly. To improve the probability of success, you need adequate knowledge, the right strategy and sufficient risk management.
F&O income is classified as non-speculative business income in India. So, it is added to your total income and taxed at the slab rates applicable. This means you can claim expenses related to your trading activity as deductions from the business income. In addition to income tax, Securities Transaction Tax (STT) will be levied at 0.02% on futures and 0.1% on options (w.e.f October 1, 2024).
Futures and options are complex financial contracts and hence, they are not generally recommended for beginners in trading. They involve high levels of risk and require a deep understanding of market dynamics, leverage, strategy and risk management. If you are a beginner, it is advisable to first gain experience in spot markets and thoroughly educate yourself about derivatives before venturing into F&O trading.
The F&O turnover is calculated as the sum of the absolute values of the profits and losses from your trades during the given financial year. Mathematically, the F&O turnover formulas are as follows: Futures turnover = Sum of all gains + Sum of all losses. Options turnover = Sum of all gains + Sum of all losses + Options premium received.
The time taken to activate your F&O trading account varies from one broker to another. Most leading brokerage service providers complete the onboarding process within 24 hours from the time you complete your application. Some may take 1-3 business days.
