Why Bank Nifty Option Trading is Better than Future Trading?

Bank Nifty Options Tips for Intraday Trading

In our previous article, we gave a short introduction to the bank nifty index and its derivatives i.e. the Bank Nifty Futures and the Bank Nifty Options. In this article, we are analysing these derivatives even further and discussing why options are more popular among traders than futures.

Until now what we know is that derivatives are essentially types of contracts that derive their value from their underlying assets, the bank nifty index being the underlying here and that the price movements in the underlying effect the price movements in the derivatives.

Although they share some similarities, the differences between futures and options significantly impact their risk/reward profiles. In general, futures are more efficient and control larger amounts of underlying assets, whereas options are more flexible and affordable.

For revision purposes, we shall have a look at what we studied previously. Options and futures are similar trading products that provide investors with the chance of making money and hedging current investments. An option gives the buyer the right, but not the obligation, to buy or sell an asset at a specific price at any time during the life of the contract. Meanwhile, a futures contract gives the buyer the obligation to purchase a specific asset, and the seller to sell and deliver that asset at a specific future date unless the holder's position is closed before expiration.

Key differences

Apart from the fundamental difference, other things set both options and futures apart. Here are some other major differences between these two financial instruments. Despite the opportunities to profit with options, investors should be wary of the risks associated with them. Also, both options trading and futures trading can be equally risky if one’s ability to produce fairly accurate analysis and outlook of their underlying asset is no good. 

Options

Because they tend to be fairly complex, options contracts tend to be risky. Both call and put options generally come with the same degree of risk. When an investor buys a stock option, the only financial liability is the cost of the premium at the time the contract is purchased.

However, when a seller opens a put option, that seller is exposed to the maximum liability of the stock’s underlying price. If a put option gives the buyer the right to sell the stock at 500 per share but the stock falls to 100, the person who initiated the contract must agree to purchase the stock for the value of the contract, or 500 per share.

The risk to the buyer of a call option is limited to the premium paid upfront. This premium rises and falls throughout the life of the contract. It is based on several factors, including how far the strike price is from the current underlying security's price as well as how much time remains on the contract. This premium is paid to the investor who opened the put option, also called the option writer.

The Option Writer

The option writer is on the other side of the trade. This investor has unlimited risk. Assuming in the example above that the stock goes up to 1000. The option writer would be forced to buy the shares at 1000 per share to sell them to the call buyer for 500 a share. In return for a small premium, the option writer is losing 500 per share.

Either the option buyer or the option writer can close their positions at any time by buying a call option, which brings them back to flat. The profit or loss is the difference between the premium received and the cost to buy back the option or get out of the trade.

Futures

Options may be risky, but futures are riskier for the individual investor. Futures contracts involve maximum liability to both the buyer and the seller. As the underlying stock price moves, either party to the agreement may have to deposit more money into their trading accounts to fulfill a daily obligation. This is because gains on futures positions are automatically marked to market daily, meaning the change in the value of the positions, up or down, is transferred to the futures accounts of the parties at the end of every trading day.

Futures may not be the best way to trade stocks, for instance, but they are a great way to trade specific investments such as commodities, currencies, and indexes. Their standardized features and very high levels of leverage make them particularly useful for the risk-tolerant retail investor. The high leverage allows those investors to participate in markets to which they might not have had access otherwise

The margin requirements for major commodity and currency futures are well-known because they have been relatively unchanged for years. Margin requirements may be temporarily raised when an asset is particularly volatile, but in most cases, they are unchanged from one year to the next. This means a trader knows in advance how much has to be put up as an initial margin. On the other hand, the option premium paid by an option buyer can vary significantly, depending on the volatility of the underlying asset and broad market. The more volatile the underlying or the broad market, the higher the premium paid by the option buyer.

This is a substantial advantage of futures over options. Options are wasting assets, which means their value declines over time—a phenomenon known as time decay. Several factors influence the time decay of an option, one of the most important being time to expiration. An options trader has to pay attention to time decay because it can severely erode the profitability of an option position or turn a winning position into a losing one. Futures, on the other hand, do not have to contend with time decay.

This is another major advantage of futures over options. Most futures markets are very deep and liquid, especially in the most commonly traded commodities, currencies, and indexes. This gives rise to narrow bid-ask spreads and reassures traders they can enter and exit positions when required. Options, on the other hand, may not always have sufficient liquidity, especially for options that are well away from the strike price or expire well into the future. 

Futures pricing is intuitively easy to understand. Under the cost-of-carry pricing model, the futures price should be the same as the current spot price plus the cost of carrying (or storing) the underlying asset until the maturity of the futures contract. If the spot and futures prices are out of alignment, arbitrage activity would occur and rectify the imbalance. Option pricing, on the other hand, is generally based on the Black-Scholes Model, which uses a number of inputs and is notoriously difficult for the average investor to understand.

We would say that for beginners, Options Trading is less risky than Futures Trading for a number of reasons.  

• Firstly, bigger rewards come with bigger risks. Futures trading is capable of producing return on investment and leverage far greater than can be attained in options trading.  
• Secondly, when an investor buys a call and put option, his maximum risk is limited only to the amount of money he used when buying those options. The worst that can happen is that his prediction is wrong and the options simply expire worthlessly. He doesn’t lose more money than that. However, in futures trading, he is subjected to unlimited liability and will be expected to "top up" his daily losses by the end of each day in what is known as a margin call. This daily loss continues as long as the stock continues to go in the wrong direction.
• Thirdly, in futures trading, if that initial few days of the drop is serious enough, he would be forced by margin call to top up his losses and if he doesn't have the money to do so, the position is liquidated and he ends up owing money to his broker even if the stock does go up after a few days more. However, if he bought call options, he loses nothing even if the stock drops for a few days before rising
• Fourthly, there are literally hundreds of options strategies an investor can use to profit from as many as all 3 directions simultaneously. Such versatility is lacking in futures trading of course. In futures trading, it usually is a single directional bet unless one uses some arbitrage strategies which also exist in options trading anyways. 
• Generally, option premiums are smaller than futures margins. As such, an investor can obtain an option position similar to a stock position, but at huge cost savings.
• More leverage. Option contracts for a given underlying are listed with many different strike prices and expiration dates, meaning that there is a large array of premiums available to options traders. In other words, you can control the amount of leverage you are willing to use. Futures contracts have no premiums, and leverage depends only on margin requirements.
• Flexibility. Long option positions are not obligated to exercise their options. Physically settled futures are always exercised at expiration.

In conclusion, we can say that, both options and futures are designed to be hedging tools, not speculative tools and futures trading has been extremely valuable in the area of commodities hedging where farmers secure the price of their produce early through buying futures contracts hence hedging against the risk of a drop in price. When used speculatively, futures are capable of producing a fortune overnight but it is also capable of wiping out a fortune and put an investor in debt overnight. As such, it is definitely riskier than simply buying stock options. Having reviewed the primary advantages of options, it's evident why they seem to be the center of attention in financial circles today. With online brokerages providing direct access to the options markets and insanely low commission costs, the average retail investor now has the ability to use the most powerful tool in the investment industry just like the pros do.

So, if you want to make money quickly and in a lesser time frame during the course of the day, then none can beat our Bank Nifty Option Tips as it performs like a precision-guided rocket and remember that Bank Nifty option trading can be undertaken in less than Rs 10,000 per lot. Are you ready to capture your profit?