Futures and options Trading

Aniket and Hardeep are best friends and colleagues in a MNC. While Aniket is an active trader, investor and financial wizard, Hardeep has just started showing interest in the world of trading.

Aniket has been actively teaching him a lot of things since the past 2 months about topics related to mutual funds, equity market, currency futures, forex options, how to open trading account, etc. Hardeep is beginning to gain confidence and has started mutual fund investment through SIP.

Today, Aniket is explaining to Hardeep about how currency prices have a direct impact on investment returns, price of essentials, fuel costs and lending rates. Hardeep is listening intently, and naturally for a newbie, he still has a lot of questions.

Hardeep – Why do the value of forex or currencies fluctuate?

Aniket – Well, there can be several reasons for the value of a currency to come down or go up. But one thing is for sure; it has a direct impact on your investment returns and many other things.

Hardeep –Really? Will you explain in detail?

Aniket – Yes. But let me answer your first question.

The value of a currency or its foreign exchange (forex) value moves according to these six main factors:

1. The exchange policy of the country’s central bank
2. Rate of inflation
3. Interest rates
4. Current account deficit
5. Government debt
6. Speculation

These are six main factors that drive the value of a currency.

Hardeep – Ok. But how do forex movements affect my investment returns?

Aniket – Yes. I’m coming to that. There is a certain type of risk in investment; it is called currency risk. A sudden significant decrease in the value of the country’s currency, which seldom occurs, can wipe out your returns. However, even minor fluctuations can impact your investment returns.

Hardeep – How is the value of the currency, for example the Indian Rupee, is calculated?

Aniket – Most currencies are valued against the US dollar. Currently, the Indian currency is valued at more than Rs. 75 against the US dollar.

Current economic and political conditions also have a bearing on the value of the currency. However, the most important factors are international trade, inflation, interest rates and political stability.

Hardeep – Can I take part in currency trading?

Aniket – Yes, you can. You just need to open trading account.

In India, currency trading mostly occurs through currency futures.

Hardeep – Now, what is currency futures?

Aniket – Currency futures are not currency in themselves but they derive their value from an underlying currency such as the INR, USD, GBP, Yen & Euro traded in India. All currency futures trades are settled in INR in India.

Hardeep – Where is forex or currency trading done?

Aniket – The NSE and BSE provides trading in currency futures and currency options. Usually, the INR/USD pair is the most popular because it has greater liquidity than other currency pairs.

Hardeep – How can we protect our investments from currency risk?

Aniket – You can use derivative instruments such as currency futures and currency options, also called forex options, to protect their investments from forex movements. If you are about to spend money in a foreign currency, you can invest in a currency derivative instrument to protect yourself against rise in valuation of the foreign currency.

Imagine, you are sending your daughter to the U.S. for higher education and you have paid 50% of the tuition fees to the university in advance. Currently, the INR is trading Rs. 75 to the USD. You are worried by the time that your daughter leaves for the U.S., the Rupee may devalue further, perhaps to Rs. 80 against the dollar. Therefore, you will be paying extra for your daughter’s higher education in the next two months or so. To protect against this risk, you can buy currency futures or forex options.

Hardeep – Can small traders trade in currency futures?

Aniket – I think currency futures trading is well within reach of small retail traders. For example, the minimum cost of a USD/INR futures contract is around USD $1,000. It is 1,000 Euros for EUR/INR futures contract and 1,00,000 Yen for JPY/INR futures contract. Profit and losses in a futures contract are paid and collected on the same day, therefore there is no chance of accumulating losses.

Hardeep – Thanks my friend, for answering all my questions on forex trading today. I have really learned a lot from you in the past two months.

Aniket – My pleasure, friend!

Investment portfolios are often composed of diverse asset classes. These usually are stocks, mutual funds, ETFs, and bonds. Options are an additional asset class. If used appropriately, options trading offers numerous advantages that dealing in stocks and bonds alone do not. Before we address these benefits, what are options?

What are Options?

An ‘option’ is a contract that permits (but doesn’t necessitate) an investor to purchase or trade instruments like securities, ETFs or index funds at a pre-decided rate after a specified period. Selling and purchasing options are carried out in the options market. An option that permits you to acquire shares sometime in the future is referred to as a “call option.” On the other hand, an option that enables you to sell shares sometime in the future is a “put option.”

Difference Between Options Trading and Other Instruments

Options are considered lower risk instruments than traditional futures contracts used in stock, index and commodity trading. This is because of the fact that one can choose to walk away from or withdraw their options contract at any time. This also means that, unlike stocks, options do not represent having ownership in a company. The market price of the option (also known as its premium) is, therefore, a portion of the underlying security or asset.

How Does Options Trading Work?

When an investor or trader buys or sells options, they have the right to apply that option at any point before the date of expiration. Simply purchasing or selling an option doesn’t require one to actually exercise it at the expiration point. Due to this structure, options are considered ‘derivative securities’. In other words, the price is options is derived from other things like the value of assets, securities, and other underlying instruments).

Benefits of Options Trading

• Buying options requires a lesser initial expense than acquiring stock. The price of obtaining an option (premium and trading fee) is a lot cheaper than what a trader would have to spend to purchase outright shares.
• Options tradinglets investors freeze the price of their stock at a specified amount for a certain period. Depending on the category of the option used, the fixed stock price (also known as the strike price) guarantees that one will be able to trade at that rate at any point before the options contract expires.
• Options tradingimproves a trader’s investment portfolio through added income, leverage, and even protection. A common way of using options to limit one’s downside losses is in the form of a hedge against the declining stock market. Furthermore, options can be used to produce a recurring source of income.
• Options trading is inherently flexible. Before their options contract lapses, traders can employ various strategic moves. These include using options to buy shares to add to theirinvestment portfolio. Investors can also try buying the shares and then selling some or all of them at a profit. They can also sell the contract at a higher rate to another investor before it matures and expires.

How to Use Call Options

A call option enables a trader to acquire a certain quantity of shares in either bonds, stocks, or other instruments like indexes and ETFs at any point before the contract expires. When purchasing a call option, to make profits, you would prefer that the asset or security price increases. This is because your call options contract enables you to purchase that underlying asset or security at the predetermined rate which is lower. Hence, in this case, you receive a discount when you use your call options contract to make a purchase.

However, do keep in mind that you will have to renew your call option (usually on a quarterly, monthly, or weekly basis). This is why options are known to continuously experience a ‘time decay’, which essentially means that they decay in value over time. When it comes to call options, look for lower strike prices, as this suggests the call option has more intrinsic value.

How to Use Put Options

A put option contract gives the investor the opportunity to sell a specific quantity of shares of some underlying security, asset or commodity, at a pre decided rate before the contract expires. With such contracts, one can make profits in case the asset or security prices drop in the future. This is done by selling underperforming shares at a predetermined price closer to the original price using the put option.

It’s also possible to reduce one’s net loss with put options. Suppose you buy stocks worth Rs 2500 with a put option worth Rs 2250 as you are predicting that their market price will drop. Within a few months’ time, assuming these stocks underperform at Rs 2000, you can sell them for Rs 2250, which reduces your net loss to Rs 250 instead of Rs. 500. Similar to call options, put options undergo time decay. However, to find an intrinsically valuable put option, look for initially higher strike prices.

Future and option contracts are among the key instruments of derivatives trading. Derivatives, for the beginner, are contracts the value of which depends on underlying assets or sets of assets. These assets could be bonds, stocks, market index, commodities or currencies.

Nature of derivative contracts

There are four key types of derivative contracts including swaps, forwards, futures and options.

– Swaps, as the name suggests, are contracts where two involved parties may exchange their liabilities or cash flows.

– Forward contracts involve over-the-counter trading and are private contracts between a seller and a buyer. Default risk is higher in a forward contract, wherein the settlement is towards the end of the agreement.

– In India, the two most widely recognised derivatives contracts are futures and options.

– Futures contracts are standardised and can be traded in the secondary market. They let you buy/sell underlying assets at a specified price that are delivered in the future.

– Stock futures are those where the individual stock is the asset that’s underlying. Index futures are those where the index is the asset that’s underlying.

– Options are contracts wherein the buyer has the right to sell or buy an underlying asset at a specific price and a set frame of time.

– There are two options contracts: call and put. 

How to start F&O trading?

Much like shares are traded in the cash market or exchanges, F&Os are also traded in India’s stock exchanges. This option was launched in India’s stock exchanges in the year 2000. You would need a trading account, aka derivative trading account, to start your F&O trading. You can trade in F&O from anywhere with the help of such an account.

– It has to be noted that futures are not available on all stocks but a select set of stocks.

– You can take up F&O trading on indices such as NIFTY50, NIFTY Bank, NIFTY Financial Service and NIFTY Midcap.

– You would also need to understand the concept of margins when you begin trading in F&O. Your broker collects margins whether you are buying/selling futures contracts. Your account needs to have a funding of margins before you start trading on futures.

– To buy options, you would need to deposit premiums. Premiums are paid to the seller by the buyer.

– Most broking houses also provide an online margin calculator to let you compute margins.

– The margin percentage varies from one stock to another on the basis of risks involved.

– You can buy F&O contracts for one, two or three month periods.

– Contracts can expire only on the last Thursday of each month. In case that Thursday happens to be a holiday, the previous trading day is considered the date of expiry.

– You can sell a contract at any time before the expiry date. In case you don’t do so, the contract expires and the profit or loss is shared.

Advantages of F&O trading?

The biggest advantage of F&O trading is that you can trade without actually investing in the asset – you don’t have to buy gold or any other commodity such as wheat, for instance, and still reap the benefits of fluctuations in the price of such commodities. The same principle applies for futures and options trading in the stock market — you don’t have to invest in the asset per se. Yet another advantage of F&O trading is that the cost of transactions is not very high.

1. Able to transfer the risk to the person who is willing to accept them
2. Incentive to make profits with minimal amount of risk capital.
3. Lower transaction costs
4. Provides liquidity, enables price discovery in underlying market
5. Derivatives market are lead economic indicators

Conclusion

It is important that you do your research before you set up that trading account. Getting a grip on the concepts and prices help.a great deal. Futures and options trading is ideal for traders who are looking at the short term and have tolerance to risk. Also, many experts suggest that a beginner could start with the equity cash trading segment for a while before moving on to the futures and options segment. That said, trading in derivatives is not rocket science, provided you have the right broking house and access to research and advice.

Across the world and in India too, F&O represents the hottest-selling stock segment. Traders love the idea of having to pay only a fraction of the stock’s actual price. Once you understand how to mitigate your risk, you could join countless investors who swear by F&O as a rewarding investment option.

What are F&O stocks?

Futures & Options stocks, abbreviated as F&O stocks come under the category of derivatives. This means that they do not have any independent or standalone value, but rather derive their value from the stock price of the chosen stock by a given date. For example, in Futures if a stock is valued at Rs 1000 today and you expect it to be valued at Rs 1200, let’s say by March 2020 for example, you can decide to buy a futures contract (for say 100 shares) on the stock in question for Rs 1000. If the price rises to your anticipated 1200, then you will have made Rs 20,000 on your futures contract. The point is that the sale or purchase as chosen by you will compulsorily take place within the contract period.

When it comes to Options, the fundamentals are the same as Futures except that there is no compulsion to buy (referred to as a call option). Options are the safer but also less profitable option according to seasoned F&O traders.

How do I go about making my first move?

You do not need a demat account to begin trading in F&O stocks. You simply need to open a trading account to park your initial margin with a trusted, well-experienced broker or trading platform, such as Angel One.

What happens to the initial margin? How long is it tied in for?

The initial margin is linked to your F&O contract. Contracts, available on the Angel One F&O Trading platform are usually available for one-month, two-month and three-month periods.

What must I know as a newbie to trading in Futures & Options?

• – Buy early: Beginners often make the mistake of buying derivativestoo close to D-day, or in this case, the day that the results are declared. However, you pay a higher price per share on contracts purchased during this volatile period so it is best to buy earlier, when prices are down. It is advisable to purchase Futures contracts, available on the Angel One F&O Trading platform for at least one month.
• – Contract period: The expiry date for your contract is the last Thursday of the contract month. If you have not closed your position or withdrawn your profits (derivative traders call this Squaring Off) at any time during your contract period, your contract expires naturally and your broker will intimate you about your profits.
• – Keep track of your spends, profits and losses: Tally up your brokerage and government-levied charges such as GST and Stamp Duty against your profits to be sure that you are indeed making profits. Maintain a journal of profits and losses, set targets and know when to pull out.
• – Play safe: You stand to gain large amounts when investing in derivativesbut it is advisable bet small initially because you could also lose the equivalent amount if the stock price does not go in the direction that you had projected.
• – Buyer versus seller: Yash buys and Nisha sells a Futures contract on the Angel OneF&O Trading platform for Rs 9000. When the results are declared, the stock is valued at 10,000. So Yash has made a profit of 1000 per share while Nisha made a loss of Rs 1000 per share. This buyer-seller equation changes drastically in the case of Options where the buyer’s loss is curtailed to the premium amount paid but the seller’s risk exposure is unlimited.
• – Do you have enough chips? During the period of maximum volatility just before the results on stocks are declared, the margins on stocks could rise drastically. You could have bet 10% but today the margins are 30%. Your broker might call upon you to increase your margins – alternatively your number of shares held (or positions) drops in order to accommodate the expanded margins.
• – F&O ban: The Stock Exchange sometimes imposes an F&O ban. It is imperative to not make any F&O moves at this time as you can be penalised up to Rs 100,000 for such a violation.

How can I know whether a broker is legitimate?

A broker must have membership to a stock exchange. For example, Angel One is a Trading and Clearing Member of NSE F&O Segment and BSE Derivatives Segment.

Conclusion: F&O stocks make for a lucrative investment option given you understand the space and have the time and attention-to-detail required to maintain records and watch your positions keenly.

As an online trader or investor, you must file tax returns for your investments, regardless of whether you have made a profit or loss. Now, you may be wondering how to file returns for your portfolio.

Reporting profit and loss from multiple trading and investment-related transactions can seem to be daunting. But not if you are a trader on Angel One. We have partnered with Quicko and ClearTax to make sure filing tax returns does not intimidate you ever again! Both Quicko and ClearTax are online tax planning and filing platforms that help simplify the entire income tax e-filing process for you.

But before getting into it, as an investor/trader, it is important to understand how trade and investment-related income is taxed.

How to Report Loss from F&O Trades?

Under section 43(5), F&O loss in the income tax return (ITR) is to be considered non-speculative business income under PGBP (Profits and Gains from Business and Profession). Therefore, the traders need to file their F&O income tax details under form ITR3, which is designated for PGBP income. In other words, any losses or profits must be reported via this form. It is the norm for individuals, companies or other legal entities.

How to Compute Income From F&O?

In case of calculating turnover from F&O for tax filing purposes,

Turnover for F&O Trading = Absolute Profit

Therefore, absolute turnover here refers to the sum of positive and negative differences.

Note: The calculation of options trading turnover has been updated as per the eighth edition of the guidance note dated 14/08/2022 (applicable from Assessment Year 2022-23). Earlier, turnover in options trading included “Absolute Profit + Premium on Sale of Options.”

Example:

Suppose Mr. A buys –

10 futures at ₹100 per future and sells them at ₹110.

20 options at ₹50 per option and sells them at ₹40.

Therefore, absolute turnover for Mr A would be –
₹ [(110-100)*10]+[(50-40)*20] = ₹300

As you can see, a negative outcome like in the second trade is ignored, and its value is taken to be positive, despite the loss.

Deposit Advance Tax on Gains

If you have gained more than ₹10,000 from F&O trading in a financial year, you are liable to pay tax on the income in advance. At least 15% of the total tax due should be deposited by June 15th, at least 45% by September 15th, at least 75% by December 15th, and the entire balance by March 15th.

What About Other Equity Trades on Angel One?

In addition to F&O trading, there are other types of stock trading, such as intraday trading, as well as short-term investment. Needless to say, you must also file ITR for share trading incomes. The rules on ITR for stock traders may be different from the F&O taxation rules:

Intra-day trading: Its income should be computed as business income but separate from F&O trading.

Short-term investment: A large volume and high frequency of short-term trades in equity shares may be treated either as business income or capital gains. Choose the basis with due diligence and reiterate it consistently across financial years.

Long-term investment: Gains from long-term equity investments may be treated as capital gains.

Let us now go over the details of the tax planning and filing process for your Angel One trades and investments. We will look at the various documents needed and how to plan and file your ITR efficiently using platforms such as Quicko and ClearTax.

ITR Forms Applicable for Traders

The following are the relevant documents related to ITR for F&O traders on Angel One, choose the one applicable to you:

1. ITR2 – Choose this form if you are treating your income as capital gains wherein the details of income are categorised under Schedule CG. The losses incurred are categorised under Schedule CYLA and Schedule BFLA.

2. ITR3 – This form can be used for futures and options (F&O) trading. More details will be given in the following sections.

3. ITR4 – This form is applicable if you follow a presumptive income scheme and declare profits at 6% of your turnover.

Documents Required to file ITR for traders

For ITR e-filing, keep the following documents handy:

1. Form 16
2. Form 26AS tax credit statement
3. Aadhar card
4. Bank statement when interest received is above Rs. 10,000
5. Trading account statement from the broker

To make filing taxes related to your trading and Demat account easy, Angel One has partnered with Quicko and ClearTax. Read on to know more about it.

How to File Taxes with Quicko?

Follow these simple steps to import all the trades data from Angel One to Quicko for filing taxes:
1. Plan your taxes by importing all the data related to your trades:

a. Go to Planning > Tax P&L.

b. Click on Angel One.

c. On the next screen, enter your Angel One credentials to log in. Your tax details related to Angel One will be synced.

Note: Currently the integration with Angel One is supported in the Filing section only, due to some intermittent issue. Alternatively, you can import trades using Quicko Templates.

Note: Once you import your trading data, your Business & Profession Income will automatically be calculated based on the nature of your trades. You will be able to import Equity, Equity Derivatives, Currency & Commodity Derivatives trades. However, data on Mutual Fund trades will not get imported.

2. File your tax returns via Quicko:

a. Go to Filing > INCOMES > CAPITAL GAIN from the side navigation.

b. Click on Import from Broker.

c. Select Angel One > CONTINUE.

d. On the next screen, enter your Angel One credentials to log in.

e. Wait a few seconds to let your Angel One account’s Tax P&L sync with Quicko.

How to File Taxes with ClearTax?

E-filing income taxes via ClearTax is easy. Follow these simple steps for swift ClearTax ITR filing:
1. Visit the ClearTax website and log in to your ClearTax account.

2. Go to ‘Income Sources’ and then scroll to ‘Capital Gains Income’. Click on ‘Add Details’.

3. You will reach a page titled ‘Import data directly from your broker(s). Click on Angel One, and a window will open titled ‘Import from Angel Broking’.

4. Click on ‘Login & Import’. Thereafter, enter your Angel One credentials to log in to your Angel One account.

5. Your trading data will automatically be imported from Angel One to ClearTax. Data related to equity, mutual funds, intraday trading, derivatives trading, etc. will be shown category-wise.

6.Your ClearTax ITR for trades and investments on Angel One is recorded. Click on ‘Continue’ to move on to other taxes, if remaining.

You can also file your taxes using Quicko and ClearTax from the Angel One app without switching to other sites. To do this, log in to Angel One. On the homepage, scroll down to ‘External Services’, where you will find tax filing options via Quicko and ClearTax.

Additional Points To Remember When Filing Taxes Relating to Trading

1. Consequences of Treating Income as Business Income

When income or profits obtained from trading and investing is treated as business income, the following consequences take place:

– Expenditure incurred under administration would be categorised as deductible.

– Securities transaction tax (STT) will also come under the deductible category.

– Losses incurred while trading in futures and options (F&O) can be utilised to balance against gains from other sources such as property or any other source, except the taxpayer’s salary.

– On the other hand, losses that have not been absorbed can be carried forward for up to 8 years but can solely be set off against non-speculative income.

– In cases where the income from F&O is above ₹1 crore, a tax audit takes place.

Example:

Suppose you have made losses in F&O trades worth ₹1 lakh. But you have made gains worth ₹2 lakh in other non-speculative incomes. Then your total taxable income for the year becomes ₹1 lakh i.e. 2 lakhs minus 1 lakh. That is how the F&O loss in ITR will offset incomes from other sources to reduce the overall income.

2. Consequences of Treating Income as a Capital Gain
When income or profits obtained from the trading of F&O is treated as capital gain, the following consequences take place:

– STT will not come under deductible, unlike expenditures, in Futures and Options.

– Any losses will be categorised as short-term capital loss, which can be utilised to balance capital gains earned via other means. Such a loss can be carried forward for up to 8 years.

3. Expenses That Traders Can Claim on Income from F&O

Taxpayers are permitted to claim deductions from F&O taxation on the following expenses incurred during business operations:

– Brokerage fees and commission, subscriptions to trading-related journals

– Consultant charges and salaries of individuals hired to assist you in your business

– Postage charges, travel and conveyance expenditures

– Telephone or fax expenses

– Internet expenses

– Depreciation on assets utilised for business operations

But it is important that you maintain the receipts or bills for such expenses. Also, any expense over ₹10,000 on a single day must not be paid in cash to be deemed valid.

4. When to Maintain the Book of Accounts?

If you are running a business as an individual or HUF, you can be required to maintain accounts related to F&O taxation if:

– your income is above ₹2.5 lakhs or

– your turnover is above ₹25 lakhs in any of the 3 preceding years, or in the first year in case of a new business.

These rules apply to individual F&O traders as well. But your accounts will be simpler. Just keep your trading statements, expense receipts and bank account statements.

In case you are following a presumptive income scheme and declaring profits at 8% of your turnover under Section 44AD, then you are not required to maintain books of account. However, if you declare profits at less than 8%, then you must maintain books of account.

5. When to Get the Audit Done?

– Tax audit requirements are covered under Section 44AB of the Income Tax Act, 1961.
Under Section 44AB(a), auditing account is required for F&O traders with business income above ₹10 crores.

– An individual or entity with a turnover up to ₹2 crore can declare their taxable income at 6% of their total turnover. This scheme is called the presumptive taxation scheme.

– As per, Section 44AB(e), tax audit will also be applicable if all the following conditions are met together –

a. The loss or profit from F&O is lower than 6% of the trading turnover (8% in the case of non-digital transactions).

b. You have opted out of the presumptive taxation scheme in any of the preceding 5 previous years.

c. Your total income exceeds the basic exemption limit.

– Also, tax audit is necessary if Section 44AD(4) is applicable and the taxable income is greater than the basic exemption limit.

If you follow a presumptive income scheme and declare profits at 6% of your turnover, then you have to file ITR4. However, you will be required to file ITR3 if you declare your F&O income as a presumptive business with capital gains.

Final Words

Filing taxes is an important part of being a responsible citizen of India. Quicko and ClearTax are here to make this experience a seamless and pleasant one!

For more such updates on Angel One, follow the Angel One blog or join the Angel One community page! Open Demat account with Angel One if you wish to invest in stocks, commodities, currencies, etc.

FAQs

Trading in futures and options has become a popular activity among traders, owing to the availability of multiple online trading platforms. Futures and options (F&O) are two types of derivatives — special contracts whose value is derived from the price of an underlying security or asset, and are available for trading in the Indian stock market. Furthermore, the F&O segment over any other market segment accounts for the majority of the trading across the stock exchanges in the country.

Futures and options are contracts between parties, which takes place through the trading mechanism in stock exchange. In futures trading, the trader can either buy or sell a security in an index or a stock contract at a predetermined value or price, at a certain date and time. For instance, investors who are interested in investing in either gold or oil can either buy them physically, or can trade in their derivatives, and enter into a futures contract to trade either gold or oil at a future rate that is predetermined.

In futures trading, the trader either makes a profit or loss depending on the market movement through the contract life, and the profit or loss is calculated every day until the end of the contract, or until the trader sells the contract. The buyer however does not have the option to cancel the contract once both parties enter the agreement.

Unlike in futures trading, the buyer does have the option to cancel the contract in options. However, considering the buyer is given this advantage, they have to pay a premium when they enter into the options contract. Furthermore, the buyer has to pay the premium amount even if they opt to cancel the options contract.

What is F&O Turnover

Calculating the turnover on futures and options trading is important for tax filing purposes, and F&O trading is often reported as business while filing tax returns. But one has to first analyse the total income for the year, which can be a positive or negative value (profit or loss). Expenses directly related to F&O business are deducted from the income, such as broker’s commission, office rent, telephone and internet bills etc., along with the depreciation on assets used for the business. The amount left will be the turnover from the F&O trading.

How To Calculate F&O Turnover

To calculate the futures and options turnover, one has to take care of the following:

1. While calculating the turnover, the total of positive and negative differences are to be considered
2. The premium received by the trader while selling the options has to be included
3. In case of reverse trades entered by the trader, the difference thereafter will also be a part of the turnover

In simpler terms, under F&O trading, the turnover of futures will be the absolute profit, which is the sum of positive and negative differences.

Futures Turnover = Absolute Profit (sum of profit and loss made on various transactions throughout the year)

The turnover of options can be calculated by adding the premium obtained on selling the options to the absolute profit.

Options Turnover = Absolute Profit + Premium obtained on selling the options

F&O Losses and Tax Audit

Regardless of the profits or losses, F&O turnover has to be reported. However, F&O losses come with tax benefits; Tax Audit u/s 44AB is applicable when the taxpayer either reports losses in the turnover, or if the trading turnover exceeds Rs. 1 crore, or Rs. 2 crores, if covered by the presumptive taxation scheme. The taxpayer can also decide not to claim, and carry forward the loss, in which case the tax audit can be avoided, and the loss can be set-off against future profits since F&O losses are non-speculative, to reduce income tax liability.

If the taxpayer decides to go with the tax audit, they must appoint a Chartered Accountant in order to:

1. Prepare Financial Statements (Profit and loss – balance sheet)
2. Prepare and file Tax Audit Report (Form 3CD)
3. Prepare and file ITR

Conclusion

F&O trading has become an attractive proposition due to the availability of multiple trading platforms. Taxpayers often get confused while filing taxes about the income generated by F&O trading, and it is important to understand how to calculate F&O turnover for income tax purposes, and when tax audit is applicable.

Future and option contracts are among the key instruments of derivatives trading. Derivatives, for the beginner, are contracts the value of which depends on underlying assets or sets of assets. These assets could be bonds, stocks, market index, commodities or currencies.

Nature of derivative contracts

There are four key types of derivative contracts including swaps, forwards, futures and options.

– Swaps, as the name suggests, are contracts where two involved parties may exchange their liabilities or cash flows.

– Forward contracts involve over-the-counter trading and are private contracts between a seller and a buyer. Default risk is higher in a forward contract, wherein the settlement is towards the end of the agreement.

– In India, the two most widely recognised derivatives contracts are futures and options.

– Futures contracts are standardised and can be traded in the secondary market. They let you buy/sell underlying assets at a specified price that are delivered in the future.

– Stock futures are those where the individual stock is the asset that’s underlying. Index futures are those where the index is the asset that’s underlying.

– Options are contracts wherein the buyer has the right to sell or buy an underlying asset at a specific price and a set frame of time.

– There are two options contracts: call and put. 

How to start F&O trading?

Much like shares are traded in the cash market or exchanges, F&Os are also traded in India’s stock exchanges. This option was launched in India’s stock exchanges in the year 2000. You would need a trading account, aka derivative trading account, to start your F&O trading. You can trade in F&O from anywhere with the help of such an account.

– It has to be noted that futures are not available on all stocks but a select set of stocks.

– You can take up F&O trading on indices such as NIFTY50, NIFTY Bank, NIFTY Financial Service and NIFTY Midcap.

– You would also need to understand the concept of margins when you begin trading in F&O. Your broker collects margins whether you are buying/selling futures contracts. Your account needs to have a funding of margins before you start trading on futures.

– To buy options, you would need to deposit premiums. Premiums are paid to the seller by the buyer.

– Most broking houses also provide an online margin calculator to let you compute margins.

– The margin percentage varies from one stock to another on the basis of risks involved.

– You can buy F&O contracts for one, two or three month periods.

– Contracts can expire only on the last Thursday of each month. In case that Thursday happens to be a holiday, the previous trading day is considered the date of expiry.

– You can sell a contract at any time before the expiry date. In case you don’t do so, the contract expires and the profit or loss is shared.

Advantages of F&O trading?

The biggest advantage of F&O trading is that you can trade without actually investing in the asset – you don’t have to buy gold or any other commodity such as wheat, for instance, and still reap the benefits of fluctuations in the price of such commodities. The same principle applies for futures and options trading in the stock market — you don’t have to invest in the asset per se. Yet another advantage of F&O trading is that the cost of transactions is not very high.

1. Able to transfer the risk to the person who is willing to accept them
2. Incentive to make profits with minimal amount of risk capital.
3. Lower transaction costs
4. Provides liquidity, enables price discovery in underlying market
5. Derivatives market are lead economic indicators

Conclusion

It is important that you do your research before you set up that trading account. Getting a grip on the concepts and prices help.a great deal. Futures and options trading is ideal for traders who are looking at the short term and have tolerance to risk. Also, many experts suggest that a beginner could start with the equity cash trading segment for a while before moving on to the futures and options segment. That said, trading in derivatives is not rocket science, provided you have the right broking house and access to research and advice.