InvestorQ : Should activate my F&O trading facility and also trade in futures and options? I only hope that not a very risky thing to do?
Juvina Maggie made post

Should activate my F&O trading facility and also trade in futures and options? I only hope that not a very risky thing to do?

Angel dcosta answered.
10 months ago

First and foremost, there is absolutely no harm in activating your F&O trading with the broker. The bigger question is when and how to trade in the F&O market. I am sure you are worried about Warren Buffett calling these derivative products as weapons of mass destruction. I must add here that while there are risks, F&O trading can be profitable and meaningful if done in the right manner. F&O trading can help you put limited capital to better use. Here are some basic points to remember and that can improve your F&O experience.

Know your risk capacity before getting into F&O trading

One of the reasons the SEBI insists on more elaborate documentation for F&O is to ensure that you have the risk capacity. F&O trading is similar to equity market trading since it calls for a lot of discipline to be able to make profits consistently. The only difference is that F&O is slightly more complicated as a product than equities. There is a leverage aspect to it and there is also a risk management aspect to it. The answer lies in managing your risk and putting limits to the risk that you are willing to take. This has to be done at multiple levels. Here is how you can do it. Firstly, put a limit to the amount of capital you can afford to lose on each trade. Secondly, limit the capital you are willing to lose on any particular trading day. Lastly, determine how much of your original capital you are willing to lose. When you reach that point, you must have the discipline to get back and rethink your strategy.

F&O is like borrowing, so use it sparingly

People often argue that futures’ trading is smarter because you can increase your ROI since you only pay a margin. There is a downside to this argument since even your losses can multiply. Hence, when you leverage it is apt to keep strict stop losses and tight profit targets. If you feel that the risk is too high you can look at trading that stock through stock options rather than through stock futures. You must ideally avoid overnight risk, especially in situations like these when the trade war and BREXIT are putting tremendous pressure on global markets.

Start off by using F&O to hedge your risk

Hedging is one of the primary purposes of F&O and you must start using it as a hedging product. This works in two ways. For example, if you have bought shares of Reliance and the stock is up 15% in 3 months, you can lock in the profits by selling futures. You may limit further appreciation but you are now assured that 15% profits are locked in irrespective of how the price moves. You can also protect a falling stock by buying lower put options. Once you understand hedging, F&O trading is a lot simpler.

Use hybrid strategies to get the best out of F&O

Hybrids Let us say that ahead of elections, you were expecting huge volatility but were not sure of the direction. How can you play this trend? That is where F&O comes in handy. You can create a strangle buying a call and put option. You risk would be limited to the total premium. But on a day like 23rd May, you would have probably made money on the call and the put option because the market gyrated substantially both ways. That is the unique feature of using options and it is a very smart way of trading directionless markets.

Start small positions and test it before doing big

This role of F&O is often underappreciated. For example, if you believe that a stock like SBI would benefit from a turnaround in PSU banking, you can implement your view through call options. If the view goes against you, then all you lose is the premium. If it moves in your favour, then you get almost the same benefits as buying the stock. Step up your risk gradually rather than just jumping into it.