Table of contents:
- 1 Overview: Similarities and differences of options and futures
Futures and options are futures contracts and are among the most important financial instruments for professional traders – alongside shares and ETFs. In this article we will talk about similarities and differences between options and futures, as well as their characteristics and possible applications.
Overview: Similarities and differences of options and futures
|Derivative financial products include||Derivative financial products include|
|are traded on futures and options exchanges||are traded on futures and options exchanges|
|conditional forward contract||unconditional forward contract|
|unilateral commitment||mutual obligation|
|can be bought and sold (long & short position)||can be bought and sold (long & short position)|
|directional & non-directional trades possible||only directional trades possible|
|Trade with leverage possible||Trade with leverage possible|
|ideally suited for traders||ideally suited for traders|
|are used by commercial market participants for hedging||are used by commercial market participants for hedging|
|mostly very liquid, for some underlyings illiquid||very liquid|
|tradable on most liquid futures, as well as on shares and ETFs||tradable on commodities, indices, energy, bonds, food, currencies|
In the following we will go into some of the above mentioned points in more detail:
Exchange-traded futures contracts
Futures and options are traded on futures exchanges
Futures and options are standardized futures contracts and are traded on futures exchanges such as the CME in Chicago, NYMEX in New York or Eurex in Frankfurt. Whereas trading used to take place on the floor, nowadays futures and options are also traded almost exclusively electronically.
Both futures and options belong to the group of financial derivatives. They were mainly developed for commercial market participants to hedge against price fluctuations, but of course they also gave speculators and traders the opportunity to profit from them.
A future or futures contract refers to “something else” (underlying) – for example, a precious metal or a type of grain. The term of the future is limited. Each contract purchased is matched by exactly one contract sold. The buyer undertakes (if he holds the contract to maturity) to buy a certain quantity of the underlying at a certain price. The seller undertakes to deliver the underlying.
Options are conditional forward contracts
As just mentioned, futures are therefore an unconditional forward contract, as the buyer and seller enter into a commitment. The most important difference between futures and options is that the latter is a conditional futures contract.
This means that the buyer of the option – as the name suggests – has the option or the right to buy or sell the underlying in a certain quantity at a certain price, but not the obligation.
Imagine you own Apple shares and want to hedge against falling prices. You could buy an option to sell (put) on the stock market, which gives you the right to sell your shares at the current market price within a period of, say, 100 days. If the price falls, you can sell at the current market price and you will not suffer a loss; if the price rises, your shares will increase in value, but you will lose the option premium you have already paid.
Who trades in futures and options
Get to know the different market participants
To find out who is trading in options and futures, you only have to take a look at the weekly CoT report, which shows the number of open contracts of different trader groups. (commercial hedgers, large speculators, small speculators)
For example, we use Crude Oil WTI with the abbreviation CL. Let’s look at a weekly chart; below it we see the respective positions of the Commercials, the Large Speculators, as well as the Small Speculators – the number of long contracts held and the number of short contracts held.
(Note: For simplicity, this is the number of futures contracts held, excluding options. The numbers with options are very similar)
It is clearly evident that commercial market participants (hedgers) hold by far the largest number of contracts, followed by the major speculators. The small speculators (non-reportables) hold a comparatively small number of contracts.
Options and Futures for prviate traders
Which product is better suited for trading?
If you want to trade profitably, you need to know the markets you are trading in and the market participants. As we have seen, both futures and options are products that are mainly used by professional market participants to hedge against price fluctuations.
Futures and options therefore differ significantly from warrants, certificates or CFDs, for example, and as traders we find ideal conditions for profitable trading.
But is futures trading or options trading now better suited for private traders?
This question cannot be answered in a general way. Let’s take a look at which instrument is better suited for which trading approach:
Directional vs non-directional trading
In trading – especially in options trading – a distinction is made between directional trading and non-directional trading.
With most financial instruments, only directional trading is possible. This means that you go long or short and only earn money if the underlying moves in the direction you want.
With non-directional trades, however, you can also earn money if the underlying moves sideways or even against you or in both directions.
Directional trading with futures
With futures you can take long or short positions and thus profit from rising as well as falling prices. It is therefore an instrument with which you can only trade directionally.
Non-directional trading with options
With options, directional trades can also be made. However, options also allow non-directional trading. This means that instead of speculating on where the price will go, you now speculate on where the price will not go. With the right strategies, the chances of success are significantly higher than with directional trading.
In addition, you can speculate on rising or falling volatility and profit from it without “predicting” where the price of the underlying will go.
Read my other articles about options:
- Bear Call Spread Options Strategy
- Bull Put Spread – Earn Money With Puts And Limit Risk
- Butterfly Spread Options Strategy
- Definition Of Option Price/Option Premium
- Earn Money With A Covered Call Options Strategy
- How to exercise Options
- How to use the Standard Deviation for Options Trading
- Iron Condor – Profit From Low Price Fluctuations
- Options Trading Tutorial for beginners
- Options vs. Futures – Two Different Types Of Futures Contracts
- Options vs. Warrants – 4 Differences
- Protective Put – Hedging Of Equity Positions
- Simple Trading Strategies for Options
- Term structure options
- What are options? – Explained Simply And Quickly
- What is a Long Call in Options Trading?
- What is a Long Put in Options Trading?
- What is a Short Call in options Trading?
- What is a Short Put in Options Trading?
- What is delta in Options Trading? – The Most Important Key Figure
- What is Historical Volatility in Options Trading?
- What is the Gamma in Options Trading?
- What is the Implied Volatility Of Options – Important Or Not?
- What is the Theta in Options Trading?
- What Is The Vega Of An Option?