How to Invest in Futures and Options

In FY2024–25, total derivatives turnover on the National Stock Exchange (NSE) reached ₹6,183.91 lakh crore, pointing to the extent of trading participation in futures and options. With participation at this scale, it becomes useful to pause and look more closely at how these instruments function. This blog explains what futures and options are, how investing in them typically takes place, and the key risks that tend to matter along the way.

What Are Futures and Options?

Futures and options are part of the derivatives market, where contracts derive their value from an underlying asset rather than from ownership of the asset itself. The underlying asset may be an equity share, an index, a commodity, or a currency. What changes hands is not the asset itself, but exposure to its price movement.

A derivative contract does not involve possession. Instead, it creates a binding financial relationship defined by price, timing, and obligation. Ownership rights are replaced by contractual commitments.

A future is a contract that fixes a price today for a transaction scheduled on a future date. Both parties are bound by the agreement, regardless of how market prices evolve before expiry. Once entered, the obligation remains unless the position is closed.

An option is structured differently. It grants one party the right to act while placing the obligation on the counterparty. The buyer of the option may choose whether to exercise the contract. The seller must comply if that right is exercised.

Example
Consider an airline company called AirWaves, which plans to buy fuel three months from now. The fuel is currently priced at ₹78, but the prices tend to fluctuate. The company enters a fuel futures contract locking in a price of ₹80.
After three months, if the prices rise to ₹90, the higher fuel cost is offset by gains on the futures contract. If prices fall to ₹75, the airline may pay more than the market price but benefits from stable and predictable fuel costs. The aim here is stability, not upside.

Now consider Rohan, a trader ahead of an RBI announcement. Bank Nifty is at 44,200, and he buys a 44,500 call option for ₹145. If the announcement aligns with market expectations and the index rises to 45,000, the option’s value increases quickly. If the outcome disappoints and the index stays near 44,200, the premium gradually erodes. The focus here is capturing price movement, not managing costs.

The instruments remain identical. The intention does not.

How Futures Trading Works

In futures trading, contracts are standardised and traded on an exchange. Standardisation allows large volumes of participation while ensuring uniform settlement and pricing transparency. Every futures contract follows predefined terms. These include:

• The underlying asset
• Contract size or lot size
• Expiry date
• Price quotation

Once a futures position is established, it is marked to market at the end of each trading day. Gains and losses are calculated daily and adjusted through the margin account. This daily settlement mechanism prevents the accumulation of unchecked losses.

Settlement therefore occurs continuously rather than being deferred entirely to expiry. Even if a position is held for several days, capital availability changes daily based on price movement. Unlike spot transactions, outcomes are recognised incrementally. Each trading session contributes to the final result.

Hypothetical Example: A NIFTY futures contract trades at 19,500. A participant enters a long position.

• On the first day, the contract closes at 19,620, resulting in a credit.
• On the second day, it closed at 19,430, leading to a debit.
• On the third day, it returned to 19,500.

Although the price ends where it began, margin balances fluctuate across days. Liquidity becomes relevant alongside direction. Futures trading, therefore, links price movement and capital flow more closely than spot trading.

How Options Trading Works

Options introduce structural asymmetry. One side purchases a right. The other side assumes a conditional obligation. This imbalance shapes pricing behaviour and risk exposure.

Each option contract specifies:

• A strike price, which sets the reference level.
• An expiry date that defines the contract’s lifespan.
• A premium, representing the cost paid for the right.

In options trading, contract value responds to more than price movement alone. Time decay, volatility shifts, and interest rate expectations all influence valuation. As a result, options behave in non-linear ways.

Time works continuously. Volatility can reprice contracts even when the underlying asset remains stable.

Hypothetical Example: A stock trades at ₹800. A call option with a strike price of ₹820 and two weeks to expiry trades at ₹12.

• If the stock moves quickly to ₹850, the option value rises sharply.
• If the stock moves gradually to ₹825, the option may still decline.
• If the stock remains near ₹800, the premium erodes over time.

Correct direction alone does not determine the outcome. Timing and volatility matter equally.

Margin, Leverage & Lot Size Explained

Margin, leverage, and lot size together shape how exposure is created in derivatives. They influence how much capital is set aside, how large a position becomes, and how strongly price changes are felt. This interaction sits at the heart of margin trading in futures and options.

Margin: Margin is the capital deposited to initiate and maintain a position. It functions as a performance guarantee rather than a purchase cost. Margin requirements vary by contract and volatility conditions.

Leverage: Leverage arises because the margin represents only a fraction of the total contract value. Exposure, therefore, exceeds deployed capital, increasing sensitivity to price changes.

Lot Size: Lot size defines the minimum quantity per contract. It standardises trade size and directly affects exposure magnitude.

Consider an index futures contract with

• Index level at 20,000
• Lot size of 50
• Contract value of ₹10,00,000
• Margin requirement of ₹1,20,000

A 1% index move equals a ₹10,000 change in contract value. Relative to margin, this represents an 8.3% fluctuation.

In this setup, lot size defines exposure, margin determines capital blocked, and leverage shapes sensitivity to price movement.

Steps to Start Investing in F&O

Getting into futures and options usually doesn’t happen in one clean move. For most people, it unfolds gradually, with understanding building in pieces rather than all at once.

Step 1: Set up access

The starting point is a trading and Demat account with a broker that supports F&O. Because derivatives are handled differently from regular equity trades, this access is enabled separately, often after acknowledging margin usage and settlement-related conditions.

Step 2: Understand the trading setup and contract details

Once access is active, the platform becomes the place where things start to make sense. Prices, expiries, margins, and contract details sit together, and over time, it becomes clearer why similar contracts can behave in very different ways.

Step 3: Observe market behaviour

This is where many people slow down. Watching futures prices or option chains during the day shows how premiums, volume, and volatility shift as conditions change. The focus here stays on noticing patterns rather than taking action.

Step 4: Place the order

When a contract is selected, orders are placed by setting quantity, price, and order type. Futures often move in line with the spot market, while options react more to strike choices and remaining time.

Step 5: Monitor open positions

After execution, positions change day by day. Prices move, margins adjust, and trade records build up. Keeping an eye on these shifts helps track how exposure and capital evolve over time.

Risks Involved in Futures and Options

Derivatives concentrate exposure, which brings distinct forms of trading risk that tend to emerge quickly once positions are active. These risks arise from both market behaviour and contract structure.

Market risk: In F&O, market risk relates to changes in the underlying asset’s price. Since contracts track this price closely, gains and losses adjust quickly, sometimes within the same trading session.

Leverage risk: Leverage risk exists because F&O positions often represent a value larger than the capital committed. As a result, losses can grow faster than the margin deposited when prices move unfavourably.

Liquidity risk: Liquidity risk appears when contracts do not attract enough buyers or sellers. During low-volume or stressed periods, exiting or entering positions smoothly may become difficult.

Volatility risk: Volatility risk is especially relevant in options. Changes in market volatility can affect option prices even when the underlying asset shows limited movement.

Operational risk: Operational risk comes from execution or interpretation errors. In F&O, this may include selecting the wrong contract or misreading expiry and settlement details, leading to unintended exposure.

Taxation of F&O Trading

In India, derivative trading is taxed differently from equity investing. Income from F&O is not treated as capital gains. Instead, it falls under business income, reflecting how derivative contracts function within organised exchanges rather than long-term ownership.

This treatment appears in the Income-tax Act, 1961, where futures and options traded on recognised exchanges are treated as non-speculative, meaning profits and losses are handled under business income rules.

Under this framework,F&O taxation applies in the following ways:

• Profits from F&O trading are taxed as per applicable income slab rates.
• Losses may be set off against other business income in the same financial year.
• Unadjusted losses can be carried forward for the prescribed period, subject to timely filing.
• Tax audit requirements may apply if turnover exceeds the thresholds.

Turnover in F&O trading is calculated differently from cash equity trades. Instead of contract value, it is generally computed using the absolute profit and loss from trades, which can affect audit applicability.

Is F&O Suitable for Beginners?

Futures and options introduce their structure upfront. Pricing responds to multiple factors at once, margins change as positions evolve, and settlement rules operate continuously rather than at the end. These features are part of how F&O instruments are built, not aspects that appear later with experience.

For beginners, this means the learning curve begins immediately. Results tend to reflect how well the mechanics are understood rather than how long someone has been active. In this context, suitability is shaped more by clarity around structure and process than by time spent in the market.

Conclusion

Futures and options reflect a market segment where expectations, uncertainty, and structure converge. Their mechanics amplify outcomes without discriminating between intent or experience. Understanding how margin, leverage, and time interact becomes more relevant than directional accuracy. For some, these instruments function as risk management tools. For others, they remain vehicles for price exposure. The distinction lies not in the contract, but in how its structure is engaged.

FAQ‘s