Derivative trading is when you trade in financial contracts whose value is determined by an underlying asset. A derivative is a financial contract and it can be stocks, commodities, indices, currencies, exchange rates etc. In the derivative market, you can trade in derivatives in the form of Futures and options contracts. Hence it is also called as Futures and Options Trading.
When trading in Futures and options, a Futures Contract is when you have the obligation to buy or sell an asset at a specified price and time in the future. This is in agreement with the other party involved. Options trading is when you have the right but no obligation to buy or sell an asset at a specified time and price in the future.
If you want to start trading in futures and options, then here are a few mistakes which you should avoid.
Don’t use futures as a proxy for trading
This is one huge mistake which you should avoid. In Futures trading, your profits can multiply but so can your losses. Leverage is something which can work in your favor or against it.
Use Stop/Loss in Futures
The Stop/Loss feature can help you manage the risks involved in futures trading. When there is leverage involved you need to keep a strict Stop/Loss target when you trade. When you earn the set profit, use the feature and exit the futures position.
Future prices are impacted by dividends and that is not a discount
It is a myth that investors trading in futures do not have to worry about dividends. Dividends impact futures. For e.g.; If ABC company is quoting at Rs 1,000 in the cash market and there is a payable dividend for Rs 50, then the price of the future for the month will be adjusted downwardly. The learning here is that you should not jump the gun and buy the futures at the discount rate.
Do Not Sell the Futures If Another Institution Is selling it
There is a possibility that the institution selling the futures might be creating an arbitrage position. A major chunk of the trading in futures is cash-future arbitrage.
Do not buy sell non-liquid futures
Mid-size and small-cap futures are vulnerable to vanishing liquidity. This trend can be spotted when there is a market sell-off. Huge vanishing volumes are created and this can be
Do not get attracted by low price options
Many trades fall for trading in options which are priced cheap as there is a low premium to pay. You can check the intrinsic value of a particular option and then buy it if it is underpriced.
Avoid holding longs when expiry is nearby
An Option has two main components:
- Time Value
- Intrinsic Value
An option which is going to expire at zero will see a rapid dip in its price as the expiry approaches. Here the key is to set your target return and exit at the right opportunity.
Trading in Derivatives has its own risks just like any other form of trading. But if you avoid the above-mentioned mistakes, then you can get some good gains through fno trading.