A derivative contract traded on stock exchanges in India is called Futures and Options (F&O). Their value is derived from an underlying asset in the form of equity shares, indices, commodities, or currencies. All details related to the structure, working, and important indicators of this segment are covered in an F&O Trading Guide for investors and traders. The Put Call Ratio (PCR) is one major indicators that are frequently referred to in F&O Trading. This article will discuss the basics of F&O, the function of PCR, and other fundamental derivative understanding in India.
What is F&O Trading?
F&O Trading refers to trading on derivative contracts. The contracts do not create any claims on the underlying asset itself, but rather bestow rights or impose obligations on it through price fluctuations.
Futures: Standardized contracts that in effect bind two parties to participate in a transaction involving a certain underlying asset at a price or specified rate agreed upon in the present, for a future specified date.
Options: Bear in it the right to buy (call option) or sell (put option) the underlying asset at a specified price before or on expiry, but assumes it is commonly agreed that such right can be disregarded by a seller.
Options and futures are by far the most popular contract types used for hedging, speculation, and arbitrary strategies.
Essential Elements of F & O Trading
Underlying Asset
Those securities on which these contracts are based; generally, stocks, indices, or commodities.
Lot Size
Minimum size of the position in units of the underlying asset as specified per contract.
Expiry Date
Expiry date for these instruments is fixed and generally the last Thursday of the month for futures and options contracts for equity derivatives in India.
Margin Requirement
An amount that is deposited or paid by a party to keep their positions open with their brokers.
Premium in options
Amount payable by the buyer to enjoy rights under the contract of option from the seller.
Market Participants in F&O
Hedger: Use F&O to guard against adverse price moves.
Speculators: Position themselves in expectations of profits on future price movements.
Arbitrageurs: Benefit from price differentials between cash and derivative markets.
A Brief on the Put Call Ratio (PCR)
Put Call Ratio is one of the most tracked indicators in F&O Trading. The PCR aims to gauge market sentiment; this indicator is calculated as follows:
PCR = Total Open Interest of Put Options ÷ Total Open Interest of Call Options
Put Options: Options to sell.
Call Options: Options to buy.
A PCR test balances between bearish and bullish positions of the market, comparing the outstanding put with other call contracts.
Types of Put-Call Ratios
PCR Based on OI (Open Interest)
Open Interest data is the data of all the outstanding contracts. Thus, it indicates the overall condition in the market.
PCR based on Volume
The volume of transactions concerning put and call options is measured over a specific period.
It is short-term market sentiment.
Reading PCR in Market Basics?
While in assessing sell pull complexities versus call, the PCR is rated, but should not be considered solely on that basis.
Higher PCR shows more puts than calls, which means that more heavier participation on the sell side.
Lower PCR shows more calls than puts, meaning heavier participation on the buy side.
Since PCR levels are not absolute, they are contrasted with historical averages or recent developments to grasp shifts in sentiment.
F&O Market Basics
1. Margins and Leverages
Under F&O Trading, only margin deposits are required for contracts and not the full value of the contract. This gives higher exposure against lesser capital, but with risk.
2. Mark to Market Settlement
Future positions shall be subject to daily mark-to-market settlement based on closing prices of the day.
3. Options Premium and Moneyness
In the Money (ITM): It means the option can have intrinsic value.
At the Money (ATM): When the strike price is very close to the price of the underlying.
Out of the Money (OTM): The option neither has some intrinsic values but only some time value.
4. Volatility
Options pricing is governed a lot by implied volatility, which tells us market expectations regarding future price changes.
Practical Uses of F&O
Hedging: Protecting one’s portfolio from downside risk by buying puts.
Speculation: Taking leveraged positions on expected price moves.
Arbitrage: Cashing in on differences between cash and futures markets.
Trading Risks of F&OP
Market Risk: Loss incurred due to adverse price movement.
Leverage Risk: Even riskier as contracts are done on margin.
Liquidity Risks: Some contracts may be illiquid, making it difficult to exit from them.
Expiry Constraints: The contracts expire weekly and monthly, hence require much timely management of the same.
Regulatory Framework
Exchanges: All F&O contracts in India are traded at NSE and BSE.
Regulator: The SEBI is responsible for regulations, eligibility of participants, and designing contracts.
Contract Notes: For compliance and transparency, the brokers provide all such details concerning executed F&O transactions.
Conclusion
This is what the F&O Trading Guide is all about. It charts the fundamental architecture of derivatives markets: futures, options, and how they operate. Put Call Ratio is studied to be a major determinant of market sentiment, also looking at the open interest in puts and calls. A grasp of margins, premiums, volatility, and risks gives breadth to the knowledge of F&L. The market basics covered here shall allow F&F participants to trade derivative contracts with a sufficiently good understanding, according to regulations and settlement processes.