MAHESH PAI explains the concept of two financial tools which can help multiply profits while being careful about losses
There was a time when the words ‘futures’ and ‘options’ sounded like something meant only for professional traders, large financial institutions and people who spent their days watching stock-market screens.
Today, it is a very different story. With a smartphone, a trading account and a few taps, an individual investor can enter the derivatives market within minutes. The ease of access has brought millions of retail investors into futures and options, commonly known as F&O. And while some traders make substantial profits, many others discover that the same instrument that can multiply profits can also multiply losses.
First, what exactly are Derivatives?
A derivative is simply a financial contract whose value is linked to something else, such as a share, an index, a currency or a commodity. Think of it like making an agreement today based on what you expect the price of something to be in the future.
1. A Future is an agreement to buy or sell an underlying asset at a predetermined price on a future date.
2. An Option is different. It gives the buyer the right, but not the obligation, to buy or sell at a predetermined price within the terms of the contract.
That may sound complicated, but the basic idea is quite simple. You are taking a position on where the price may go.
Why are F&O so attractive?
The biggest attraction is leverage. You do not always have to put up the full value of the underlying position to take exposure to it. This means a relatively smaller amount of money can control a much larger position. And this is where the excitement begins.
If the market moves in your favour, the percentage return on the money you have committed can be substantial. But leverage has a second side as well. If the market moves against you, the losses can also become substantial.
It is therefore important to remember that derivatives do not create money out of thin air. They transfer risk between participants. One person’s gain generally comes with another participant’s loss, before costs and charges are considered. SEBI itself cautions that derivatives can multiply both profits and losses and, for a person speculating without adequate knowledge, can potentially cause very large losses.
The profits are real, but so are the losses
Stories of people making lakhs from a single options trade are understandably attractive. Someone buys an option for `20, the market moves sharply in the expected direction and the option rises to `60. On paper, the investor has tripled the value of the premium.
These stories are real. But they represent only one side of the market.
SEBI’s data paints a very different picture for the average individual trader. Its study of FY2024–25 found that approximately 91% of individual traders in the equity derivatives segment incurred net losses after transaction costs. The aggregate net loss was about `1.06 lakh crore.
The important lesson is not that nobody makes money in F&O. People do. The lesson is that making money occasionally is very different from consistently making money.
The danger of trading without understanding
One of the biggest problems is that F&O can look deceptively simple. An investor sees an option priced at `50 and thinks, “I only have to invest `50.”
But the option represents a much larger underlying position. The price can move rapidly, and an option can lose most or even all of its value if the expected movement does not happen within the required time.There is also a concept called expiry. Unlike simply buying a share and holding it for years, an option has a limited life. Time matters. Being right about the direction of the market is not always enough. You can be right about the stock eventually rising and still lose money if it does not rise sufficiently before the option expires.
Then why does SEBI allow it?
Because derivatives are not inherently bad, they have legitimate purposes.
Businesses, institutional investors and sophisticated market participants can use derivatives to hedge or reduce risk. For example, someone exposed to a fall in the market can use derivatives as a form of protection. The problem arises when a product designed to manage risk is used primarily as a vehicle for speculation without understanding the risks involved.
Recognising the growing participation of individual investors, SEBI has introduced several measures to strengthen the equity derivatives framework. These measures are important because regulators cannot remove market risk. They can, however, put guardrails around how the market operates.
The real risk is overconfidence
Perhaps the greatest danger in F&O is not volatility itself. It is overconfidence.
A person makes `50,000 in one week and begins believing that they have figured out the market. The next trade becomes larger. Then another. A loss arrives, and instead of accepting it, the trader increases the position to recover the money. This is where trading can stop being an investment activity and start becoming an emotional game. The market does not know that you need to recover your money. It does not care that you made a profit yesterday. And it certainly does not owe you a winning trade tomorrow.
F&O is a tool, not a shortcut
There is nothing wrong with understanding futures and options. There is nothing wrong with using them when they fit a well-understood strategy and the risks are appropriate. The problem is entering the derivatives market because someone posted a screenshot of a large profit, because a friend claims to have made easy money, or because an online influencer makes trading look effortless. Before entering an F&O trade, an investor should understand the contract, the maximum possible loss, the impact of leverage, the expiry, the costs involved and the tax implications.
Most importantly, they should ask themselves one simple question: “If this trade goes completely against me, can I comfortably afford the loss?” If the answer is no, the potential profit should not be the reason to enter the trade. Futures and options can be powerful financial tools but power without understanding can be dangerous. The objective should not be to find the trade that can make you the most money, it should be to make sure that one bad trade cannot undo years of financial progress.