How to trade stock options and futures

Both contracts provide investors with strategic opportunities to make money and hedge current investments. Option trading provides less upfront risk for buyers given the lack of obligation to exercise the contract. However, the premium price rises and falls, allowing users to sell their calls and puts for a profit ahead of the expiration date. Meanwhile, sellers of call and put options collect a premium. The value of the contracts decays as the settlement date approaches. Futures contracts, however, offer maximum liability to both the buyer and seller of the agreement. Still, it is very rare for stock futures to be held to their expiration date. Each method offers different profit potentials for investors and speculators. But stock options also provide investors with a breadth of flexible strategies unavailable through futures trading. One of the first questions an investor must ask is how much risk they are willing to take on in their investment strategies.

Purchasers of futures contracts are obligated to buy the underlying stock from the seller of that contract upon expiration no matter what the price is of the underlying asset. As noted, investors purchase the right and obligation for fulfillment once a position is opened. Before an investor can decide to trade either futures or options, they must understand the four primary differences between stock futures and stock options. Related: Pick the Right Options to Trade in Six not difficult Steps. If the option is out of the money, the contract buyer is under no obligation to purchase the stock. However, they are not obligated to exercise the option at the time the contract expires. As the underlying stock price shifts in the favor against either the buyer or seller, parties may be obligated to inject additional capital into their trading accounts to fulfill daily obligations. Those who sell options can purchase call options in order to cover the size of their position as well.

This provides a more conservative approach, particularly if traders use a number of additional strategies like bull call and put spreads to improve the odds of trading success over the long term. The two trading tools are very different, but many first and beginner investors can be not difficult confused by the terminology. However, with stock futures, the buying party pays something different from a contract premium at the point of purchase. When someone buys a stock option, the only financial liability is the cost of the premium at the time the contract is purchased. Investors only exercise contracts when they are in the money. For a full breakdown of these opportunities, visit here. Stock futures on the other hand offer very little flexibility once a contract is opened. Those who purchase call or put options receive the right to buy or sell a stock at a specific strike price.

Should I Trade Futures of Options? Place a futures order. Stock futures trading is similar to options trading, though when the futures expire you are contractually bound to complete the purchase or sale of the stock named in the futures contract. If you plan on using futures for stock purchases you should look for stocks that are likely to continue performing well. Relatively few futures orders actually reach their date of expiration, instead being canceled by a second futures contract that takes the opposite action of the original. Born in West Virginia, Jack Gerard now lives in Kentucky.

Standard futures contracts are for the purchase or sale of 100 shares of stock, and you will need to pay a margin fee of 20 percent of the going rate per share included in your contract. Research your stock options, choosing one or more stocks you are interested futures trades for. Stock futures are contracts that state that you will buy or sell shares of a stock at a certain price on a specific date. If you plan on using futures to sell stocks you currently own, evaluate their performance and choose stocks that are doing well now but which may drop in price down the road to be worth less than you paid for them. Gerard also spent several years as a fencing coach and trainer. Ask how much their transaction fees are, what the minimum amount you need to open a margin account is, and whether they offer other investment or money management services for future reference. The new contract is created to expire on the same day as the original, buying or selling the stock at the same time as the original contract sells or buys. Tell your broker if you wish to close out your futures contract before its expiration date.

For instance, a stock trader could sell puts with the willingness to accept delivery of underlying stock should it become ITM and holding indefinitely until prices swing favorably. As a result, any explosion in volatility could provide greater risk and reward to a futures option trader than would be possible via a stock option. Nevertheless, there are arguably more disadvantages to doing so. The fundamental characteristics and mechanics of options in all arenas are identical. Even more detrimental to the method, the option must be ITM enough to recoup the premium paid to purchase the option. Unlike a stock, which has no finite life span, a futures contract does. ATM a year from now.

This means they pay half the commission upfront, and the other half when they exit. What should also be obvious, is that these differences come with higher levels of risk to speculators. It is important to know which markets have enough participants to actively trade. For those that hold options to expiration, most likely until they are worthless, there might be a small advantage in executing the trade with a stock broker offering commodity options as a side product as opposed to a traditional commodity broker who charges options upfront. This scenario is often referred to as contango. Depending on the futures market traded, the contract may expire on the same date as the option, or it may be at a relatively proximate, but distant date. Whether a commodity trader opens an account with a few thousand dollars or a few hundred thousand dollars, his positions will be levied margin based on the portfolio risk, not the individual risk of his positions.

Without the benefit of portfolio margining, the trader would be charged margin for both positions, but compliments of SPAN, the client would essentially only be charged a margin requirement for either the call or the put, whichever is deemed to hold the most risk, but not both. We are going to highlight some of the key differences, but you should consult with a tax professional for details. Such costs include warehousing, insurance and the potential interest lost on the money tied up in the physical commodity. In addition to relatively higher margin burdens for the average speculator, stock traders are often required by their broker to have the cash on hand to purchase the underlying stock should the short option be exercised. Perhaps the most significant difference between trading options on stock and options on futures is the way they are margined. Both have a relatively tight hold on the industry and work diligently to assure that proper protocol is being exercised by market participants. Commodities have a carrying charge, or cost to carry, which is the cost of storing the commodity until it is to be sold. While options on futures and equities share many common traits, there are key differences between the two that every trader must know before expanding their trading horizon. The most difficult aspect of trading options on futures is becoming familiar with how each contract is quoted.

There are several thousands of stock options listed on the various options exchanges as well as equity indexes, but there are far fewer options on futures, less than 100 with enough liquidity to be efficiently traded. There are also some peripheral differences that you should be aware of such as tax treatment, regulation and margining. The liquidity in the options on futures markets can be spotty. Traders wishing to buy an option expiring a year from now will probably have to pay the contango. Although a call and a put have the same general function, it is foolish to assume that differences in the underlying asset are irrelevant. Most commodity options provide speculators with risk exposure far exceeding that of a typical stock option.

Nevertheless, commodities themselves are leveraged so the cash outlay required to take delivery of them, should an option be exercised, is much lower than the true value of the contract. Not surprisingly, commodity options tend to be a little more expensive compared to similarly positioned stock options. Obviously, the commodity option trader is subject to favorable margins, lower potential cash outlays, and leverage. For higher priced stocks, this might be significant. Options inherently provide leverage to the buyer; however, options on futures are derivatives of an already levered vehicle. The discrepancies range from how premium is calculated, to how strike prices are displayed. In other words, they charge commission for futures and options on futures in the same manner. The tax code can be complicated, especially when it comes to paying taxes on investment income.

And corn is one of the least expensive futures markets. Like the SEC and equities, these two agencies work together to assure proper conduct in the futures industry. This can be confusing for those in the industry, let alone a beginner. This means an ATM option already incorporates a far higher price for the commodity than the current going rate. PFGBEST and MF Global. In short, commodity option traders generally face lighter margin requirements and easier access to leverage than do stock traders. Now that is leverage. The nature of the underlying vehicle and the logistics of market execution.

Thus, assuming that you traded profitably, you would be subject to a lower tax liability as a commodity option trader than a stock option trader on positions held for less than a year. Therefore, long option plays in the futures markets may be a little more challenging, but the winners have a potential to be relatively large. This means when a trade is executed, the client is charged the full commission but pays nothing when the trade is offset. Instead, OTM options expose traders to relatively mitigated risk and reward. This is important because a trader who is short a call option and a put option in the same market, cannot lose money on both sides of the trade. Consequently, there is a finite time span on option strategies in the futures markets. On a similar note, stock traders enjoy the luxury of FDIC and SIPC insurance on their cash and security holdings. Futures traders enjoy the simplicity of reporting a lump sum profit or loss of money on their tax return. Although if the position moves adversely they might eventually see their margin increase to levels nearing that of the underlying futures contract.

Unlike stocks, commodities pay no dividends. The only cash flow that occurs for a commodity trader is upon exit of the trade. Most importantly, they should be approached and traded according to these differences and the recognition that option trading, like any investing, involves risk. Additionally, being familiar with the differences in logistics and market characteristics are necessary; especially for stock traders looking to migrate into the futures markets. Unlike stock and stock option prices, which are standardized, each futures contract has a differing multiplier, contract size, and format. Stock brokers offering commodities on the side tend to charge their option traders half in and half out.

The gap represents the cost to carry the inventory to the September expiration date. Because of these costs, it is reasonable to expect that a futures contract with a distant delivery month will be higher than that of a nearby delivery month. Both stock and futures options have an expiration date. The stock market tends to profit in value over time. Presented by Charles Cochran who has over 30 years experience in the industry giving you his overview on why futures is the better way to go. An excellent summary as to Why trade futures? FREE trial, visit us at www.