Futures vs Option trading: A Complete Beginner's Guide And Strategies
Futures and options are the major types of stock derivatives trading in a share market these are contracts signed by two parties for trading stock asset at predetermine price on a letter date such contract try to hedge market risk involved in stock market trading by login in the price beforehand.
future and options in the share market are contracts which derive their price from an underlying asset such as shares stock market indices commodities ETFs and more feature and options basic provide individuals to reduce future risk with their investment through three determine price however saying the direction of price moments cannot be predicted it can cause suspense profits or lose is a market prediction is in accurate.
Futures vs. Options: What's the Difference?
Futures and options are both financial instruments used to profit on, or hedge against, the price movement of commodities or other investments.
The key difference between the two is that futures require the contract holder to buy the underlying asset on a specific date in the future, while options as the name implies give the contract holder the option of whether to execute the contract.
That difference has an impact on how futures and options are traded and priced and how investors can use them to make money.
Futures
- Contract holder is required to take ownership of the underlying asset.
- Price of the future purchase determined by current market price.
- Price can fall below $0.
- Less volatile price changes.
Options
- Contract holder has the right, but no obligation, to purchase an underlying asset.
- Price of the future purchase specified in the contract.
- Price can never fall below $0.
- Value quickly declines over time and fluctuates more widely with changes in the underlying asset's value.
Why to Invest or trade in Future & Options Market?
Prices in Futures and Options market reflect the perception of the market participants about the future and lead the prices of underlying to the perceived future level. The prices of derivatives converge with the prices of the underlying at the expiration of the derivative contract.
Thus derivatives help in discovery of future as well as current prices. The Futures and Options market helps to transfer risks from those who have them but do not like them to those who have an appetite for them. The Future and Options provide other benefits such as greater leverage, lower trading costs and longer trading hours. Further, these derivative products also offer diversification and hedging benefits which make them an attractive option for investment related purpose.
Strategies For Future and Options Trading And Investing.
Did you know that as an equity trader you can apply the same strategies to options on futures that you use with equity options? One of the benefits of being an options trader is that you can use the same trading strategy in multiple markets.
All traders have at one time or another found it difficult to consistently find new trades from their watch list; adding options on futures markets can help expand your watch list to find more trades. If you already have trade set ups for equity options, you benefit from the ability to apply those same set ups across all futures markets, thus giving you access to more trades.
Trades in options on futures can include market neutral, multi-leg and directional trades depending on your market assumption and risk/reward goals. Using the same tools you already use to create your equity market assumption about where you think the underlying will move, you can place trades to take advantage of that move. Essentially, if you already know how to trade equity options then adding options on futures becomes an easy transition and a valuable addition to your trading plan.
Take a look at some of the trade strategies you might use to trade Equity Index options that can also be used to trade options on futures.
Directional Trades
Directional trading by buying calls and puts is a common way to trade options and can be used in the same manner in options on futures. Trading options on futures by purchasing puts and calls is a way to capitalize on a fast moving market with a set amount of risk (what you pay for the option) just the same as buying a call or put in an equity option.
Other spread strategies like debit spreads can also provide a subsidized way to buy put and call options with a fixed risk and reward. Regardless of the strategy, all of the directional trades that you currently use in equities will be applicable here.
In fact, trading options on futures can, in many cases, have an advantage. Rather than trade the futures contract alone, options on futures allows a trader to make a trading assumption about the direction of price similar to trading a futures contract, but with the advantages of only risking what you paid for the option rather than the usual higher cost of the futures contract, all while taking advantage of a fast move in these markets.
Example
A trader who believes that silver is poised to move higher might buy a January $16.50 at the money call in the Silver contract for $0.38, when Silver is trading for $16.60. Their belief is that Silver will be worth more in the next month. This trader buys this call that is about one month out so that there is time for silver to rise and for him to sell the call for more than what he paid for it.
Multi-Leg Trades
Just like equities, options on futures can also be traded using multi-leg trade strategies like spreads and butterflies. Combinations can be traded as one order or add legs to existing positions to build spreads. A spread strategy can be used to take advantage of trading an expected move with a directional assumption while allowing the trader to control risk/reward at the initiation of the trade. It can also be an opportunity to trade by selling premium with less margin requirement than selling puts alone. A spread strategy will behave the same whether in equity options or options on futures.
Non-Directional Trades
Just like equity options, with options on futures, volatility traders and non-directional traders can use the same strategies which are already familiar. Non-directional traders can implement strategies like selling straddles and strangles to take advantage of decreasing volatility in a sideways market. Other strategies like calendar spreads are also possible just like with equity options.
Example
If a trader believes that YM is going to consolidate over the next few weeks, one of the ways he could trade is by selling a straddle. If YM is currently trading at 19,848, a trader could sell the Jan 31 19,850 put and call for 396 points. The strategy would pay off if YM moved less than 396 points by expiry of the spread.
As an experienced equity index trader, you can hedge your positions in a couple of different ways using the futures markets and your existing trading knowledge. You can consider combining any existing futures holdings and options on futures to create a perfect one-to-one hedge. For example, a trader who is net long the S&P in their stock holdings, could use short-term E-mini S&P 500 futures (ES) puts to help offset any downturns in the portfolio. The same is possible with foreign exchange (FX) contracts allowing traders to hedge any foreign currency exposure they might have.
A trader who has multiple stock holdings could help offset a downturn in the market by buying sufficient puts in the ES contract. The trader can choose between long- and short-term expiries depending on the time frame they wish to hedge. For example, ES is trading at 2,266. The trader could buy March 2017 2,270 puts for 46 points to hedge over the short term or buy September 2017 2,270 puts for 113 points to hedge over the longer term.