A Future and an Option are financial contracts that derive their value from an underlying asset, such as stocks, indices, and currencies. Investors and traders use these instruments mainly to hedge positions, manage risks, or speculate on price changes. F&O trading is one of the derivatives parts under the banner of which works simultaneously, supported by the stock exchanges like the NSE and BSE.
How To Start Trading in F&O?
To get into the trade-in futures and options game, do the following:
Open a Demat Account Online: Pick a broker that is registered with SEBI; normally, the procedures will involve furnishing proof of identity, proof of address, k181 pca84 card, bank details, and completing KYC.
Enable the Derivatives Segment: It will be done during the activation of your Demat Account or whenever you place a request to include the F&O segment.
Interpretation of terms related to margin management: You must be aware that F&O trading needs some margin. Hence, you should make sure to have the availability of funds before squaring off your position.
Accessing Market Platforms: Brokers provide traders with online platforms through which they view live quote details, charts to give a technical analysis, and option chains.
What is the Put Call Ratio (PCR)?
The Put Call Ratio (PCR) is an important measure in F&O trading, as it offers a cursory idea of sentiments in the options market.
The following formula gives the result:
Put Call Ratio (PCR) = Volume of Put Options / Volume of Call Options
One can also calculate the ratio using open interest instead of volume:
PCR (Open Interest) = Open Interest of Puts/Open Interest of Calls
This indicator helps traders to ascertain whether the market participants are bearish (put-heavy) or are leaning toward bullish (call-heavy) territory.
PCR Tells Us As Well:
As a numerical ratio, the put-call ratio is neutral, but is manipulated by traders for their use as a sentiment indicator. Here is how:
A PCR > 1 implies the dominance of put option activity, signaling that traders are expecting a downward movement.
A PCR < 1 means that call option activities are dominating, signaling a positive market sentiment.
One should be cautious not to use only the put-call ratio in isolation; rather, it works best with technical indicators, the price trend, and market context.
Types of Put-Call Ratios
PCR uses primary methods of measurement as follows:
PCR by Volume: This measures trading activity (number of contracts bought and sold) in put and call options relative to a specific period.
PCR by Open Interest: This measures the total number of outstanding put and call contracts at a given time.
The trading of PCR by volume really assists with the decision-making of short-term trades done during the day, while those by open interest are more suited for medium-to-long-term trend analysis.
How Do Traders Utilize Put-Call Ratio in Strategy?
Traders employ PCR while involved in sentiment analysis and when trading on momentum-based strategies. Here are a few common methods:
Strategy 1: Contrarian Approach: A high PCR may signal excessive bearish sentiment, which may be interpreted by some as a potential change to bullish; on the contrary, a very low PCR might suggest a positive market sentiment.
Strategy 2: Trend Confirmation: Held at an almost constant level with price trends, the PCR can be of support in direct trading.
Strategy 3: Market Timing: Some traders use daily changes in PCR to point out short-term market reversals.
Nevertheless, the interpretation of PCR without context can be problematic. It is one of several data points observed before decision-making by traders.
Risks and Considerations in F&O Trading
While futures and options provide scope for leveraging, they conceal a high level of risk due to margin requirements, the volatility existing in the market, and contracts that are time-bound. Major factors of importance are:
Leverage Risk: A small move in prices will yield big losses or gains to your account.
Expiry Constraint: It means an investment requiring expiry at a certain point in time may need to be principally settled should the trades not be settled.
Liquidity: Some contracts with little liquid transactions necessitate a speculative exit.
Volatility: Extremely volatile price swings or implied volatility can drag down the options’ pricing.
Under such circumstances, it would be important for the traders to put a risk-management plan in place and understand the working of F&O instruments beforehand.
Why a Demat Account is Essential?
Even though futures and options contracts are cash-settled and no shares need to be delivered, a demat account has to be opened merely for the purpose of abiding by the specified rules and regulations. The trading account is linked with the demat account by brokers for seamless processing and settlement of transactions.
Today, the popular route is online demat account opening, with many platforms providing instant activation and access to market data, charting tools, and educational content.
Conclusion
F&O trading is an integral part of the Indian financial markets, providing investors and traders the requisite tools to hedge risk, diversify strategies, or speculate. The put-call ratio, when used judiciously, can offer an insight into market sentiment, which can support trading decisions.