While some of us may a basic understanding of futures and options from text books, understanding how it actually works in the Indian market is of critical importance, if you want to trade in these instruments. whenever you make any investment or trading decision (fixed income, mutual funds, stocks or derivatives) four considerations are of critical importance:-
Your risk capacity
Your investment timeframe
Your investment expectations, risk capacity and investment timeframe should determine which asset category or sub-category you should investment. If you are trading in derivatives, it implies that, your return expectations are very high and your risk capacity is also high. Your investment timeframe at maximum is limited to expiry of the F&O series, unless you rollover your F&O positions
In F&O, you cannot wait indefinitely for prices to rise and give you good returns; F&O contracts expire on the last Thursday of the month. Therefore, it is possible that, you can lose your entire margin amount in F&O. In very bad markets, you can actually lose more than what you have invested.
Your risk capital will depend on your income, expenses, long term investment needs, liabilities, etc. Financial planning is essential, in determining your risk capital. In financial planning, you determine your short term and long term financial goals, your life and health insurance requirements and your contingency planning needs. You need to save and invest on a regular basis to meet those needs. If you have surplus funds after saving for all these important financial objectives, you can consider a portion of that, as your risk capital. Your risk capital should never be at the cost of your important financial objectives, like life and health insurance, retirement planning, children’s education etc. You should budget your investment in F&O margin accordingly.