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| What are Futures & Options? | |
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What is a Future?
A futures contract is a legally binding agreement made between two parties to buy or sell a commodity or financial instrument at an agreed price, on a specified date in the future. With futures contracts, the quantity and quality of the underlying commodity are specified and the future delivery date is fixed. The price is the only variable and is determined through the interaction of buyers and sellers at the time when the contract is first opened.
Futures contracts can be based on commodities like gold, oil and coffee, financial instruments like treasury bonds, stock market indices or shares.
Why Trade Futures?
- Futures contracts trade at centralised, government regulated exchanges which ensures fair practices. In addition, exchanges clear and guarantee all transactions, so investors and traders can have confidence that their trades will be honoured. Centralised exchanges are also liquid markets, which makes it easy to establish and offset your trading positions as desired.
- Liquidity and Spreads. A good number of the major futures markets are liquid and in some case they are considerably more liquid than their underlying markets, which makes it easy to establish or offset your trading positions. As participation in the futures markets continues to grow, liquidity rises and bid/ask spreads continue to narrow. This, in turn, makes the futures markets even more attractive for traders.
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What is an Option?
An option is the right but not the obligation to either buy or sell a stock, commodity, currency, or index at a specified price during a specified time period.
Options may allow a buyer to achieve higher returns than buying stocks. In today’s highly volatile environment, options allow the buyer to limit potential losses while retaining the potential for profits. In addition, an investor who borrows money to buy stocks is unable to deduct margin interests. Options are a great alternative because they allows for the deduction of all "margin interests."
Options can provide protection for a share portfolio, additional income or trading profits by the way of;
- Speculation. The ease of trading in and out of an option position makes it possible to trade options with no intention of ever exercising them.
- Leverage provides the potential to make a higher return from a smaller initial outlay than investing directly. However, leverage usually involves more risks than a direct investment in the underlying shares.
- Diversification. Options can allow you to build a diversified portfolio for a lower initial outlay than purchasing shares directly.
- Income. You can earn extra income over and above dividends by writing call options against your shares, including shares bought using a margin lending facility. By writing an option you receive the option premium up front. While you get to keep the option premium, there is a possibility that you could be exercised against and have to deliver your shares at the exercise price.
- For example, a stock option allows you to fix the price, for a specific period of time, at which you can purchase or sell 100 shares of stock for a premium. The option cost is only a percentage of what you would pay to own the stock outright. That leverage means that by using options you may be able to increase your potential benefit from a stock’s price movements.
* Note: the risk of loss in trading in derivatives and/or leveraged products can be substantial. A client should carefully consider whether trading such products is appropriate for them in light of their objectives, financial situation and needs.
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