Most of us wonder why the share market in India is so volatile
. It is true that our markets lack depth and are subject to lot of manipulation since the deterrent laws are not in place; it is also true that people lose money due to an excessive gambling tendency. Research shows that after Chinese, one of the most speculative communities is Indians. This speculative tendency makes share trading in India more speculative rather than investment oriented. An investor is concerned about returns but a speculator is only interested in jackpots. Overnight richness and easy money is the motive for many investors in India.
It is necessary to deter investors in India from acting out of intuition. Share trading on options market is an alternative to cut down on losses in the share market. The concept of options and futures can be better understood with an example. If a deal has been signed between two parties, which specifies that a car will be sold at Rs.3 lakhs after one month and it is made mandatory on the part of both the parties to adhere to the deal then it is an example of future contract or interest rate futures. The crux is that once a deal has been signed both the participating parties have to respect it. If the same deal had an option that allowed both the participating parties to alter the terms and conditions then it is an example of options market. In options market a small price has to be paid in the form of a deposit which is non refundable. This is called Option Premium.
According to the aforementioned definition in futures contract or interest rate futures a share needs to be purchased on the appointed date at the pre determined price. The contract needs to be respected irrespective of the prevailing market price. The risk is a probable loss of the entire purchase because the price could go very low. Simultaneously the buyer also stands to make unlimited gain if the market price soars much beyond the agreed price.
If you trade in options contract then the buyer has the leverage to back out of the deal if the current market price of the share goes beyond the agreed price. The buyer will only respect the deal provided the price of the share remains below the agreed price in the deal. The risk here is the loss of premium that was paid for the contract and probable profit of unlimited amount since the price can go to any level.
If we compare the Options and interest rate futures it is very clear that the probability of profit is unlimited in both the alternatives. However, the probability of loss is unlimited in an interest rate futures and limited to the extent of paying premium in an Options Contract.