Investing in futures contracts is considered very risky due to their low margin requirements and the guarantee of completion. Therefore, this type of trading is usually left to professional investors. The main purpose of futures contracts is to allow producers, sellers and consumers to hedge their production and inventories by „fixing“ the current futures market price when it is profitable for them. Since they are usually quite complex, options contracts are usually risky. Call and put options generally carry the same risk. When an investor purchases a stock option, the only financial liability is the cost of the premium at the time of purchase of the contract. S&P 500 futures are valued at the value of the index multiplied by $250. In other words, if the S&P 500 were at 5,000 points, the cost of the futures contract would be 5,000 times $250, or $1.25 million. Remember that the investor does not have to raise this total amount. You just need to maintain the margin required to negotiate the contract. During the tulip bulb madness, options were not only used by growers and sellers to hedge against price fluctuations, but it was one of the first times in recorded history that options contracts became a tool for speculators as they are today. For options and futures, it is important to know certain terms.
In the world of options, the terms „put“ and „call“ are essential to business. A „put“ is the ability to sell a particular asset at a specific price. A „call“ is the ability to purchase an item at a pre-negotiated price. The price itself is called the „strike price“ or „strike price“. In addition, options usually have an „expiration date“. This date is the date on which the option should be put into action, otherwise the option becomes null and void. You need a margin account to trade futures and options. Futures are agreements whereby a buyer agrees to purchase an underlying asset, usually a commodity, at a fixed price at a specific future date. For example, a futures buyer may agree to buy 100 barrels of oil at a certain price in the future, and the seller of the contract must comply with these conditions.
A key difference between futures and options is margin value management. Depending on the underlying movement in the share price, each party may need to deposit more money into the trading account to maintain daily trading obligations, which increases the overall cost of futures contracts for retail investors. Some options traders like options not to move as fast as futures. They can be stopped very quickly with a wild tipping of a forward transaction. Your risk is limited by options, so you can sit away from many wild price futures fluctuations. As long as the market reaches your target within the required time frame, options can be a safer bet. Below are some important terms of futures and options, besides the differences between the two. The most actively traded futures are stock index futures. They offer advantages in terms of liquidity, leverage and tax compared to trading index ETFs. These are very active because a lot of money is managed on the stock exchange.
Portfolio managers regularly use futures contracts to hedge their exposure. Options are also used as a speculative tool. Suppose an activist short seller publishes a damning report against a company. After reading the report, you decide to bet against the stock in one way or another. Perhaps one way to express this view is to buy long-term put options on the stock. Again, let`s say the trader speculates that the S&P 500 will rise and that it currently has a value of 5,000. Imagine that the trader buys a call option with a strike price of $5,050 and a ask price of $11.50. Investors pay a premium for options, and $11.50 is the premium in this case. The futures contract will also mention the settlement method. Futures can be bought on margin, which means traders only need to keep a fraction of what they trade in their account. Typically, the requirement is 3% to 12%, so a futures trader could invest $100,000 with as little as $3,000 of their own cash.
This will significantly increase profits – and losses. If the futures trader buys a contract at 5,000 points and moves to 5,100 points on the expiration date, the contract is now worth $1.75 million and the trader has made a profit of $50,000. Futures and options are two types of derivative securities. This means that neither options nor futures contracts have intrinsic value. Instead, they derive their value from an underlying asset, such as a commodity, currency, or stock index. Both are financial contracts that determine the terms of a transaction at a later date. Options, as the name suggests, give a buyer the option, but not the obligation, to complete the transaction. Futures contracts, on the other hand, require that the agreed transaction take place after the contract expires.
Option contracts can be concluded by the buyer at any time before they expire. Therefore, a person is open to buying the asset if the conditions seem right. When you buy an option, you pay a premium for the option. This is usually only a small amount compared to the strike price of the contract. As an option buyer, this is the biggest risk you have. An options contract can never be worth less than $0. The biggest difference between options and futures is that futures contracts require that the transaction specified in the contract take place on the specified date. Options, on the other hand, give the buyer of the contract the right – but not the obligation – to execute the transaction. We have seen the advantages and disadvantages of options compared to futures. You need to make your decisions based on your risk tolerance and investment goals.
As we saw above, futures carry a higher risk because you have to bear the weight of price changes. For options, your losses in the event of an adverse price change are limited to the premium you paid.