Options vs. Futures Advantages – How to maximize your profits
In today’s article, we’re going to highlight the Options vs. Futures advantages. Knowing what instrument vehicle to use to express your trading ideas can have a big impact on your profits. Part of finding the answer to how one can maximize his profits is just learning about each derivative instrument.
There are dozens of websites talking about futures and options trading, but unfortunately, the vast majority of them only cater to stock options trading. A lot of traders assume that if they read a book on futures vs. options trading they can just simply apply that theory to commodities, but it’s really not that simple.
Both futures and options are derivative instruments, which means there is a substantial risk of loss when trading these financial instruments.
We quite often are asked in our environment, why trade futures?
The number one reason is that the future contracts are designed for trading, they are not an investment and you don’t own the underlying instrument. Secondly, like Forex trading, there’s a tremendous amount of leverage in trading futures. The day trading margin requirements can give you a leverage of 100:1 and overnight margins can use leverage as high as 25:1 and as low as 6:1.
Futures and options are instruments that can actually be profitably traded. So, if you want to be a trader, futures instruments are the answer.
First, let's discuss what futures and options are and how they can help you limit risk exposure, while still having the potential to gain quick profits.
What are Futures and Options Contracts?
In this segment, we’re going to talk about the basic of the futures vs. options market and about the market mechanics. Let’s begin by reviewing the futures contracts:
In the financial world, a futures contract is an agreement to make, or, take delivery of a commodity like gold or crude oil and a number of agricultural goods, at a fixed date in the future. There are also futures contracts on financial instruments such as treasury bonds and Fx currencies. So, futures derive their price from an underlying asset.
When dealing with futures, the price of the transaction is determined “right now” in the open market.
Futures trading started around 150 years ago, so there is nothing new about this new form of trading. They offered producers and consumers of these commodities a way to buy and sell goods on the spot, and then defer the delivery date. Farmers could sell crops before the harvest, and deliver them afterward.
Since futures are standardized contracts, there are a few terms you need to learn if you’re going to trade futures. This is the beginner’s guide to trading futures that will outline all the components of a futures contract:
Contract size or quantity: Each contract represents a fixed and standard weight, For example, in the Gold futures market, a standard contract is 100 troy ounces of gold. In the currency futures, depending on the ticker symbol, the standard contract may vary. The Euro futures contract has a standard size of 125,000 euros. The crude oil futures contract has a benchmark contract that is worth 1,000 barrels.
Payment Terms: This describes where and when delivery will take place, and under what payment terms. In plain English, the buyer and sellers indicate that they accept these terms by trading the contract.
Expiration Date and Delivery: This is the time when the contract is going to expire, but since most trading is speculative in nature, people will not take delivery of let’s say 1,000 barrels crude oil, but instead these contracts are sold before expiration or rolled over, so traders can avoid delivery.
Initial Margin: Which is the amount of margin that you have to put up to trade 1 futures contract.
Unlike Forex, futures are exchange-traded contracts which means there is a lot more price transparency.
One option is a contract that gives you the right, but not the obligation to buy or sell at a specific price. For example, if you buy an option to buy 100 Apple shares at the strike price of $150, this gives you the right, but not the obligation to buy 100 shares at $150 per share at any time between now and whenever the option expires.
If the Apple shares go up in value to $170, then you can exercise your option and the person who sold you the option is forced to sell you 100 Apple shares at $150 even though the shares are currently worth more than that.
Next, we’re going to discuss the difference between a future and an option.
What’s the Difference Between a Future and an Option?
If you thought that futures and options are different from each other, then you’re right. Some traders commit themselves to only trade futures, while some people exclusively trade options, however, each has their advantages.
Next, you’re going to learn how they differ from each other.
Options enable the trader to effectively trade futures but without the potentially unlimited risk normally associated with futures contracts. Due to the rapid change in the supply and demand equation of the underlying asset, there is a potential rapid price movement in a future contract.
For example, stock options give you the right but, not the obligation to buy or sell for a pre-determined price anytime up to an agreed expiration time.
There are a couple of inherited advantages between futures options vs. stock options. There are favorable margin requirements and you can implement a variety of strategies when trading futures.
The bottom line is that trading futures provide an alternative to mitigate risk and provides the best vehicle for getting into the stock market especially compared to options.
Options vs. Futures Advantages
The first thing to keep in mind is that options generally cost much less than the current share price.
In the example above, buying 100 Apple shares at $150 each would cost you $15,000 whereas the option may be available for less than $500. The difference is like winning the jackpot.
With options, you get to speculate on the movement of the stock, but only add a fraction of the usual price. That’s not all because if the Apple share price crashes 40%, traders that bought Apple at $150 are going to lose $6,000, but if all you own is the option you bought for $500, the absolute most you can lose is the $500 you paid for the option
There are definitely some advantages for trading futures vs. options.
The advantage of trading futures vs options is that you have more leverage. There is some leverage advantage to futures compared to stocks and options and it’s a much more liquid market which gives you relatively low spreads. The liquidity also makes it much easy for traders to get their orders filled.
Conclusion – Options vs. Futures Advantages
One of the main advantages you have when trading futures is that you’re not limited by time decay, which is the most important element you need to take into consideration when trading options. Second, when deciding whether to trade futures or to trade options you need to keep in mind that futures trade more rapidly than options. In this regard, if you’re a daytrader, futures trading is more suitable.
The bottom line is that futures contracts have more advantages over the options contracts. However, for the versatile trader who can understand the complexity of options trading, options can be an alternative investment vehicle to express some complex trading ideas.
If the idea of knowing the exact amount of money you’re going to lose if the trade goes against you is something very appealing to you than you may choose to trade Put and Call options.
Thank you for reading!
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