Ten Commandments of F&O trading

1. Start with simple transactions

It is not advisable to get involved in complex F&O strategies if you have just started to trade in derivatives. Start with simple trades like buying and selling the Nifty and buying and selling stock futures of the 10 most liquid stocks in the F&O segment. Once you are comfortable with these basic futures transactions, you can gradually move on to buying call and put options. However, remember that writing of call and put options should only be taken up by informed investors.

2. Comprehend the benefits

Consider futures and options in its proper perspective. For example, if a person is buying 300 shares of Reliance in the cash market, he has to pay Rs4,50,000 and the trade will get settled by T+2 trading days. However, if he undertakes the same transaction in futures, he will only have to pay Rs1,25,000 which is the margin for the transaction. Now, if Reliance appreciates by 10% in 5 days, then his return on investment in the cash market is merely 10%, while it is a whopping 36% in the futures segment. Also, if he intends to trade short in the cash market, he will have to square-off his position during the day itself. However, in case of futures, he can carry forward his short position until expiry

3. Contract value does not matter

Many investors are of the view that the minimum contract value of Rs2 lakhs in F&O is too high. It needs to be understood that Rs2 lakh is the notional contract value and not the amount that investors have to pay. For instance, if you buy one lot Nifty futures in the F&O market consisting of 50 units, the notional value may be Rs3.25 lakhs. However, you need to pay only the margin amount of Rs25,000. This is definitely not a very large sum for any investor who is serious about investing in the markets.

4.Stop loss is a must

We often come across friends who are stuck in their positions as they failed to adhere to the recommended stop loss. Please understand that by following stop losses, you can restrict your losses if the market goes against you. Please ensure that if you are taking any position in the F&O market, you strictly abide by the recommended stop loss.

5.Diversify across recommendations

On any average day, there is a possibility that an F&O recommendation can go wrong due to factors which are beyond one’s control. If you happen to take a position in a recommendation which later goes wrong, then you tend to develop an aversion to other recommendations that may later prove to be profi table. Hence, it is important that you take positions in all recommendations so that your risk can be minimized.

6. The brokerage myth

It is not necessary that low brokerage services always translate into high profi ts. Such low-cost services often lack quality in the recommendations that may lead to inferior returns over a period of time. On the other hand, good quality is refl ected in ideas backed by sound research. However, this quality might come at a price (high brokerage), but it will convert into superior returns in the long term.

7. Don’t panic when in loss

Generally, investors tend to panic when the market goes against them. The F&O market has suffi cient fl exibility to bail you out in most situations. The markets are volatile by nature. For example, you bought Reliance futures at 1900 and it has come down to 1540. However, if your advisor is confi dent that it will not cross 1900 then you can write a 1900-strike call option and reduce your cost of holding. Remember, when you panic, you subsidize the person who does not do so.

8. Profit is what you book

Greed tends to take a grip of most investors in the market, especially in F&O. Hence, it is critical that investors do not get too greedy and book profi ts when their target return is achieved. Suppose if you have bought Nifty futures at 2800 and your one-month target return is 3%, then book profi ts at 2880, even if your broker has given you a target of 3010. It makes sense to book profi ts twice rather than try to wait too long. In the market, what you book is your profi t, and anything else is purely a notional one.

9. Assured returns are dead

Investors should never look for guaranteed return in the F&O market. Anyone looking for assured return should not invest in equities, but stick to RBI bonds. It is important to understand that F&O offers all the benefi ts of the cash market with some additional advantages, but is surely not a product that can be termed risk-free.

10. Stick to one trading methodology

Each brokerage house follows its own method of research which will be different from others. It is advisable for an investor to follow one brokeragehouse for sustainable returns. This consistency significantly increases the likelihood of high returns.