If you consider yourself a trader or someone who’s interested in trading and you haven’t looked into trading Futures and/or Options, you are missing out. Forget Forex, Bitcoin, and outright Stock trading. Futures and Options provide some of the biggest, and most capital efficient opportunities.
However, there is some misinformation about Futures and Options that this article will hopefully provide some light on. There are multiple reasons that these are the two most heavily traded instruments. To not look into them would be a wasted opportunity.
Futures and Options are mainly thought of to be hedges for big businesses that deal in commodities, or financial firms looking to hedge their investments. With both Futures and Options you need a buyer and a seller to complete each transaction. Pretty basic stuff.
Another way to think about the 2 counterparties is that there is a hedger on one end and a speculator on the other end. Now we could get into the morality of speculation and try to defend the title against the constant backlash that mainstream media paints, but we won’t.
We don’t need to defend the title, because the reality is that people wouldn’t speculate unless there was money to be made.
Futures And Options Are Used Worldwide
Futures and Options trade in all 4 of the major markets (United States, Europe, Asia, and Australia). Once you know how Futures and Options trade, you quite literally have a world of opportunity available to you to trade.
Now, for the most part, I would say that if you’re actively trading you should find a market (meaning a Futures Contract, or a Stock that you would like to trade Options on) and stick to that day in and day out. It can be much easier to consistently make money by mastering one market, than changing what you’re trading each day.
That said, there are going to be times where the instrument you trade most often is going to be stuck in the mud, and not doing anything. It’s going to go through periods of low volatility, and with low volatility comes little opportunity.
During these periods you could go on vacation, or just scale back your trading.
If you’re like me, you like to be active in the market all the time. Afterall, if you didn’t love this, the emotional rollercoaster of trading would have kicked you to the curb a long time ago (or it will soon if this game really isn’t for you).
So one of the ways to avoid low volatility in the instrument you trade is to find a similar instrument in another market that you can trade.
For instance, if you trade the E-Mini S&P 500 Futures regularly, you can switch to the Nikkei 225 Futures during times of low volatility in the Spooz. The two markets are similar, but provide different opportunities. Or, if you don’t want trade outside of the US Market, you can switch to the NASDAQ 100 Futures, Treasury Bond Futures, Crude Oil, etc. The point here is that there is always something to trade.
Hedge Overnight Risk
This is actually a pretty important point to be made. If you are an investor who would like to protect your portfolio from overnight risk, you can use Futures to hedge against your positions. For instance, if some terrible news comes out overnight and you are Long a bunch of stocks, you can hedge your portfolio by going Short 1 (or however many contracts you need to) E-Mini S&P 500 Future at anytime throughout the evening.
This is great, because you don’t have to wait until the market opens the next day for you to hedge your positions. You can literally go into the Futures market at midnight, hedge yourself, and rest assured that you’re covered against further adverse movement.
Same Strategies Can Be Applied In Different Markets
While each Stock and Commodity has its own individual price behavior, you can pretty much apply the same strategies to each market. There’s a term called “product indifferent”. Once you have your own system/strategy of trading, the ticker symbol that you trade becomes nonexistent. All you’re looking at is the opportunity in front of you.
Oodles of Liquidity
It’s no secret that liquidity is one of the most important factors when trading. It’s what allows you to get in and out of positions quickly, and what allows you to get out at a decent price when you-know-what hits the fan. With Futures and Options on well-known Stocks, you’ve got all the liquidity you would ever want.
This is yet another reason that Futures and Options beat out Penny Stocks and Forex trading.
Ease of Entry/Exit
As was said earlier, a liquid market allows you to get out positions easily and at a decent price. During a market crash, or a panic, liquidity will tend to dry up. That means that potential buyers will stay out of the market and wait for Stocks to show signs of recovering, before stepping out to buy.
That’s bad news for people who have bought into an illiquid market. When prices go down, you want to get out right? If there isn’t anyone willing to buy what you’re selling, you’re screwed (that’s a technical term). You will have to ride the Stock all the way down to where bidders are at, taking the loss all the way down.
Save Money On Bid/Ask Spread
One of the signs of a liquid market is how wide the Bid/Ask Spread is. A Bid/Ask Spread of 1-tick (a “tick” being the smallest price movement in a Futures Contract) shows that the market is very liquid. A smaller Bid/Ask Spread, the more money you will save on entry and exits.
For instance, a Bid/Ask Spread that is $1 wide means you will immediately lose $1 if you were to enter the trade and immediately exist. For more on this concept, you can check out this article here.
Futures and Options are great ways to get leverage in the market, without having to go out and literally borrowing money to trade with. Futures and Options deal in margin. For your average Futures Contract, you will need $5,000 in margin to trade 1 contract. Some brokers will allow you to trade with as little as $400 in margin per contract, but that’s very risky.
Your standard Options contract represents 100 shares of Stock. There’s something called Delta that influences the price of the Option (and how much you make), but we won’t get into that here. For more info on that, you can check out this.
Can Set Your Own Level Of Leverage
This mainly applies to Futures, but the concept can also be applied to Options. You see, with Futures there’s something called “Notional Value”. The Notional Value is a very, very important concept that almost no one ever talks about. You’re in for a treat.
The Notional Value is what the Futures Contract actual controls in terms of USD. Every Futures contract deals in “tick” and “points”. As I said earlier, a tick is the smallest price movement of a Futures Contract. A point is merely the sum of all the ticks.
The amount of ticks in a point varies by product, but here’s a quick list:
- 30-Year Treasury Bonds (/ZB)
- 32 Ticks in 1 Point
- 1 Tick equals $31.25
- 1 Point equals $1,000
- E-Mini S&P Futures (/ES)
- 4 Ticks in 1 Point
- 1 Tick equals $12.50
- 1 Point equals $50
- NASDAQ 100 Futures (/NQ)
- 4 Ticks in 1 Point
- 1 Tick equals $5
- 1 Point equals $20
- Crude Oil (/CL)
- 100 Cents (Ticks) in 1 Dollar (Point)
- 1 Tick equals $10
- 1 Point equals $1,000
As you can see, Crude Oil has slightly different jargon, but the concepts are all the same. Now the real importance of Notional Value here is that while 1 point in the /ES might equal a measly $50, the actual size of the contract is $129,500.
That’s a lot of money. You shouldn’t be intimidated though. Currently, the average volatility of the /ES on any given day is about 15 points. That means that if you buy 1 /ES Future your account would be up or down $750.
For the exact math on how to calculate the Notional Value and for more info on leverage, you can check out this article.
While it isn’t advisable to trade on 20x leverage, when looking at a portfolio as a whole Futures can be a great way to speculate and hedge without using too much of your account capital. This point mainly applies to those looking to hedge their overall portfolio.
If you’ve got all your money invested in Stocks, Bonds, and/or ETFs, the advantages of the margin required to sell a Future or buy Puts against down moves in the market are negligible to the headache required to sit through down moves or flatten positions.
*Sorta. This isn’t intended to be investment advice, but rather intended to be thought-provoking. Everything has risks in life. There’s nothing that is completely risk free, and Futures and Options can be very risky if you don’t have a clue as to what you’re doing.
This one mainly applies to Options, although depending on the amount of leverage you’re using relative to the Notional Value it can apply to Futures as well. When you buy an Option, you can only lose what you paid for the Option. You hold the right, but not the obligation, to purchase/sell Stock at a certain price.
So you don’t have to exercise your right to the Option. You can merely trade the premium around it.
You can also sell Options. There’s a wide variety of strategies you can use that can increase your odds of success and do it consistently.
Liquidity of Futures Can Prevent Slippage
You have to remember that the market is a two-way auction, with real people placing orders to buy and sell. It isn’t just numbers on a screen. There are people behind the numbers. When perceived gets too high, liquidity can dry up. In other words, the Bid/Ask Spread can get very wide. With most Futures, there’s ample liquidity.
More importantly, in a market that has little liquidity, your stop-loss order can be deadly. If you have a stop-loss at $45, but the next bid below the market is $35, you will get filled at $35. A stop-loss does not guarantee your price. It just guarantees you’ll get out of the position.
There are lots of benefits to trading Futures and Options. Even if they aren’t your thing and you have no intention of actively trading them, having an understanding of what they are and how they trade can massively benefit you for when you will need to use them.
I hope this article cleared up some misconceptions, and opened some eyes. Feel free to leave a comment if you enjoyed this article or have any questions.