Options and futures are derivatives of stock traded in share markets. As such, they are contracts between two parties used for trading index and stock. This is done at a given level or price and a set date in the future. When a trade price is specified, the derivatives hedge investors against future stock-market fluctuations. However, real-time options and futures trading is more fast-moving and complex.
That is why most people deal with options and futures via a trader. Even so, it is advisable that you get basic knowledge of their functions prior to making an investment.
Options and futures-what makes them different?
Even though options and futures have some commonalities, they do have some differences. They get their value from underlying assets like ETFs (exchange-traded funds), share market indices, commodities, and shares. They both also represent future trades.
Their differences include:
· Obligations vs. rights
Futures are seen as trading commitments that will be squared off at the set date. On the other hand, options are rights given to the buyer to exercise contracts.
· Trade date
The holder of futures is expected to trade that security at the set date. When it comes to options, you have variations. Some options can be exercised at any time until the date of expiration is reached. When exercising options for indices vs. stock, you will get some nuances. For example, countries like India can only exercise index options on the day of expiration. However, you can exercise stock options anytime until the day of expiry.
· Advanced payments
When you enter into a futures contract, you won’t have upfront costs. You will only make payment when you’re squaring the future contracts off on the set date. Future contracts demand that a ‘margin’ is put up. This margin is a specific percentage of a trade’s value. As such, your losses and gains are magnified by the ‘leverage.’
There is, however, a risk associated. If there is a price drop, you have the option of opting out of options. The same option is not available for the future. This is because the trade must take place on the set date, regardless of the price. Theoretically, options reduce loss risks, although, in practice, 97% of options expire with no trade.
Types of options and futures
Futures are uniform and have the same set of rules for sellers and buyers. As for options, the two types of options are call and put options.
Call options make it possible for you to purchase underlying assets at a set price and date.
Put options make it possible for you to sell assets at a set price on an agreed-upon date.
Trade, in both cases, is optional. You have the option of choosing not to use your put or call if you see that the prices aren’t in your favor.
Who invests in options and futures?
Options and futures trading call for an understanding of the stock market nuances. It would help if you also were committed to keeping track of the market. Moreover, there is also the aspect of speculation to be considered. It is thus utilized mainly by speculators and hedgers.
- Hedgers: When hedgers invest in options and futures, they are motivated by the idea of insulation against future volatility of prices. You will find hedgers in commodity markets because there, prices fluctuate at a fast rate. Options and futures trade gives much-needed stability of price in such an environment.
- Speculators: Trading derivatives comes with an element of speculation where trade is agreed upon at a specific price. As compared to hedgers who search for stable prices, speculators are mostly found to bet against long odds. They make educated price guesses based on their news events and market study.
Options and futures assets are primarily leveraged, with options having an easier sell than futures. What you’ll most likely hear is the profit you will most likely make in the future when you fix an advantageous price. One thing you’ll not hear a lot of is the fact that margins can go either way. You may find yourself at a point where you have to sell at a price lower than the current market price. You can also find yourself having to buy at a price higher than the market price.