F&O = Futures and Options

F&O is an abbreviation for Futures and Options. Futures and Options are derivatives products. Let me explain what derivatives mean.

Definition: Derivatives are securities which derive their value from one or other underlying securities.

Simple explanation: A derivative is like buying financial product whose value is derived from the real asset. The value of the derivative would replicate the value of the real asset.

Example: If an investor wants to buy gold, he can either buy the physical gold or he can buy a derivative of gold(Eg: futures contract).

Now you may think that when the investor can buy gold directly, why would he want to buy the derivative and complicate matters? 
To answer this question, let’s take another example. Only this time we will take oil. Now as an investor, you think that the price of oil is going to go up. To profit from this you will need to buy physical crude oil barrels, which is practically impossible for most. Hence, it is easier to buy the derivative instead. For you the investor, it doesn’t make any difference as the price of the derivative will replicate that of the physical oil.

How do they work? 
Futures and options are contracts between two people. These contracts are not entered directly between the buyer and seller. They occur through the stock exchange mechanism. The stock exchange creates these derivatives. These are then made available to buyers and sellers through the exchange platform. This ensures that you are not bound to any individual to honor the contract. You can make a transaction through the stock exchange whenever you want.

Are there any added advantages?

  1. With futures and options, you can not only make profit when the asset price is increasing, but you can also make profits when the prices are falling. For example, if you think the price of oil is going down, there is no way that you can profit from it unless you have stock of physical barrels and you sell them in the market immediately. Whereas, through futures and options, you can first sell and then buy it back at a later date.
  2. Leverage: With derivative products, you can buy more amount of the asset with a smaller amount of upfront cash. It is like taking a loan and investing except that you don’t need to pay any interest for the additional amount.

Hope this helps to understand the term.

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