Derivatives trading offers flexibility, leverage and the ability to profit from different market conditions. You make profits even when the underlying asset does not move. This attracts many traders towards derivatives trading. Although these conditions give some advantages, it also increases the risk. For derivatives trading, learning the basics about the FnO is not enough. Understanding how to use them effectively is what separates preparation from speculation.
Before risking your own money, you should become familiar with some foundational strategies. These strategies are designed so that the traders can express their market view along with systematic risk management. For a derivatives trader, it is important to choose the right strategy by understanding the market.
Understanding the role of derivatives strategies
A derivatives strategy is a systematic way of using futures or options positions to accomplish a particular trading goal. Traders do not just buy or sell contracts but combine various positions based on their expectations of price movement, volatility or market direction.
For example, if you have a bullish market view, then you can use the strategies which can be beneficial in a trending market. If some believe the market will remain range-bound, then strategies like straddle or strangle can be beneficial.
Long futures strategy
The long futures strategy is one of the simplest derivatives approaches. A trader buys a futures contract when expecting the underlying asset to rise in value.
Suppose a trader believes a stock index will move higher over the next few weeks. Instead of purchasing the entire basket of stocks, they can take a long futures position through any futures trading platforms. If the index rises, the futures contract gains value.
While the strategy offers leveraged exposure, losses can also increase quickly if the market moves in the opposite direction. This makes stop-loss planning essential.
Covered call strategy
The covered call is commonly used by traders and investors who already own an asset and want to generate additional income.
In this strategy, the trader holds shares and simultaneously sells a call option on those shares. The premium received from selling the option provides income regardless of whether the option is exercised.
The trade-off is that potential upside becomes limited if the asset rises sharply. Covered calls are often used when the trader expects moderate or sideways price movement rather than a strong rally.
Protective put strategy
A protective put functions similarly to an insurance policy. If a trader owns stocks but is concerned about a downside drop in the short term, he can buy a put option. If the stock declines sharply, the gains from the put option can offset the losses in the underlying position.
For example, if you are holding a share of a company and its major earnings announcement is planned in the coming week. If you expect a high volatility during the announcement, then you can buy a put option of the same underlying asset. It reduces downside risk and protects your capital.
Bear put spread
When traders expect a moderate decline rather than a major market crash, they often consider a bear put spread.
This strategy involves:
- Buying a put option at a higher strike price
- Selling a put option at a lower strike price
By selling a put option at a lower strike price, the strategy reduces the overall cost of the trade and also maintains exposure to the expected directional move. The strategy is best fit for traders who prefer steady income as it has defined risk and defined reward.
Conclusion
Derivatives are powerful trading tools. They should be used with a clear plan and realistic expectations. While there are a number of advancedoption trading strategy available, knowing basic strategies like long futures, covered calls, protective puts, etc., is very important in the long run.
For traders preparing to go live, the goal should not be to memorise every available strategy. But they should focus on understanding how each strategy behaves, what risks it carries, and when it aligns with a specific market view.
About the Author
