After spending a lot of time explaining the differences between options trading and futures trading to derivatives trading beginners, I think it’s time to address the similarities between options trading and futures trading. Is options trading and futures trading really that different? What are some of the similarities? Well, there are actually four main areas in which options and futures are similar.
First of all, options and futures are derivative instruments. This means that both are simply contracts that allow you to trade your underlying asset at certain specific prices, therefore deriving their value from the price movements of your underlying asset. Both options and futures are simply contracts that bind the exchange of the underlying asset to a specific price. Without an underlying asset, options and futures would be worthless by their existence, which is why they are known as “Derivative Instruments.” Both options and futures exist for the purpose of facilitating the trading of their underlying asset.
Second, both options and futures are leveraged instruments. This means that both options trading and futures trading give you the ability to control price movement in more of your underlying assets than your cash would normally allow. For example, a futures contract with a 10% initial margin requirement would allow you to control ten times the amount of your underlying asset than your cash would normally allow. A call option that asks for $1.00 on a stock that is trading at $20 has twenty times leverage, since it allows you to control a stock that is worth $20 with just $1. Leverage also means that you could make more profit with options and futures on the same move on your underlying asset as if you bought the underlying asset with the same amount of cash. Of course, leverage works both ways. You could also potentially lose more than you would in trading options and futures than you would if you had simply bought the underlying asset.
Third, both options and futures can be used for hedging. Hedging is one of the most important uses of derivatives. Both futures and options can be used to partially or fully hedge the directional price risk of an asset, although options are more versatile and precise as they allow what is known as delta-neutral hedging, which allows a position to be completely Covered continue to profit if the underlying asset stage breaks sharply in either direction. The hedging power of options and futures is also extremely important in reducing the downward pressure faced by the broader market during market downturns because large funds and institutions can hedge the downside risk of their holdings using options and/or or futures instead of selling your shares to maintain the value of your account. By reducing the amount of selling by these large funds, the downward pressure on the broader market is partially alleviated. Of course, this alone does not stop bear markets from forming when the general retail crowd (also known as the “herd”) begins to run out of the market.
Fourth, both options and futures can be used to earn profits in ways other than the price movement of the underlying stock itself. Futures spreads can be used to speculate on seasonal price differences between the price of futures contracts of different expiration months, and option spreads can be structured to take advantage of time decay no matter which way the trend is. underlying asset. Yes, it is these options strategies and future strategies that make derivatives trading so interesting and rewarding for people with a knack for calculations and mathematical strategies.
So, even though options and futures are very different derivative instruments and have very different trading rules and characteristics, they are still very similar in the above areas and you can be a more well-rounded and savvy trader or investor by understanding how use both. options and futures in your favor.