Trading in options and futures comparison
This would be like buying in bulk and unfortunately Futures traders cannot buy or sell the individual units of the Commodity as their fellow traders can in the Equity markets.
When a Futures trader sees a last price on their chart, in a newspaper or on a TV screen they are seeing a unit price for that Commodity. But like all other Commodities, Crude Oil is not traded as a unit. It is traded as a contract that has multiple units in it.
The Crude Oil contract calls for delivery of 1, barrels units of Oil. The only other option a Futures trader has to trade smaller contracts is a mini contract size. Unfortunately, all mini size contracts for Futures markets are very illiquid extremely low volume. For this reason it is recommended to avoid trading any of the mini Futures contracts.
The exception to that rule is the Stock Index mini contracts. Here the volume is much higher and more liquid than the full sized Stock Index Futures contracts. The next time you are trading Futures and see the last price on your chart, remember this only represents the price per unit and not the entire contract.
Listed below in Table 1 are some markets and their contract sizes:. Perhaps now you can see why Futures prices can be much more volatile than Equity prices. In our Crude Oil example, if a trader went long at If the price falls to As we have seen in the Futures markets this is not a big move and happens frequently. However, with the size of the contract the loss can grow exponentially. If the trader was able to purchase just one barrel unit of Crude Oil at There would be no panic in this situation.
Traders looking for smaller units to trade should perhaps consider the Farmers Market Equity Markets , allowing them to choose how many veggies they wish to take away from the market. For other traders with good risk management and a rule based strategy, then perhaps they may want to go shopping at Costco Futures Market and buy or sell in bulk where they can leverage their shopping dollars.
Disclaimer This newsletter is written for educational purposes only. The holder of an options contract has the right to buy the underlying asset at a fixed price, but not the obligation. The writer, or seller, of the contract is obligated to sell the holder the underlying security or buy it , if the holder does choose to exercise their option. This obviously puts the holder of a contract at an advantage, because if the underlying security moves against them, they can simply let the contract expire and not incur any losses over and above the original cost.
If the underlying security moves in the right direction for the holder and therefore against the writer , then the writer must honor their obligation. In a futures contract, both parties are obliged to fulfill the terms of the contract at the point of expiration. This is a very significant difference. Buying a futures contract where you will be obliged to buy a particular security at a fixed price carries much more risk than buying an options contract where you have the right to buy a particular security at a fixed price, but are not obliged to go through with it if that security fails to move up in value as you expect.
Both parties involved in a futures contract are effectively exposed to unlimited liability. The costs involved are also different.
When an options contract is first written, the writer of it sells it to the buyer and receives the money that the buyer pays. Depending on the terms of the contract, the underlying security involved, and the circumstances of the writer, the writer may have to have a certain amount of margin on hand. They may also be required to top up that margin if the underlying security moves against them.
However, the buyer owns those contracts outright and no further funds will be required from them. With futures, though, as both parties are exposed to losses depending on which way the price of the underlying security moves, they are both required to have a certain amount of margin on hand. Price differences on futures are settled daily, and either party could be subject to a margin call if the value of the underlying security has moved against them.
This contributes largely to why futures trading is generally considered riskier than options trading. Below we look at a couple of the advantages trading options has to offer. As mentioned above, when trading futures you are potentially exposed to big losses whichever side of the contract you are on.
If you have the obligation to buy an underlying security at a fixed price and the security moves significantly above that fixed price, then you could lose substantial sums. Conversely, if you have the obligation to sell an underlying security at a fixed price and the security moves significantly below that fixed price then you could experience sizable losses.
If you are writing options contracts and taking on an obligation to either buy or sell an underlying security at a fixed price, then you are exposed to similar risks.
However, you can trade options purely by buying contracts and not writing them. This means that you can limit your potential losses on each and every trade you make to the amount of money you invest in buying specific contracts. Whenever you buy options contracts, the worst case scenario is that they expire worthless and you lose your initial investment.
Even if you do want to write contracts in addition to buying them, you can easily create spreads to ensure that your losses are always limited. The potential for limited liabilities in options trading is a major advantage, particularly for those that are against high risk investments.