Why More and More Investors are Using Futures & Options
- Used correctly, futures and options are powerful investment tools that provide many advantages over trading shares, including greater certainty and precision, high liquidity, low transaction costs and leverage;
- Few investors have experienced the current levels of stock market volatility during their investing lifetimes and this uncertainty and the continuing falls in global stock markets - more than 45 per cent in the FTSE 100 alone over the past two-and-a-half years - are driving many of you to explore alternative methods of realising a profit;
- Against this background, equity futures and options (equity derivatives) are enjoying record trading levels.
Why Use Futures & Options?
Options are flexible instruments that can be used in a variety of different ways - either as a way to profit from short-term market movements, or as a part of longer-term investment strategies. In essence:
- Prices are determined by multiple brokers, traders and market makers and placed on a central order book where they are filled at the most competitive bids and offers
- Contracts are traded on a regulated exchange
- Commissions are usually specified at a fixed amount, eg £5 per futures contract
- No 'hidden charges' - prices reflecting simple 'fair' values
- Prices reflect known or expected dividends
- Lower margins compared to many other trading tools
- No stamp duty
Two key uses of options are:
- To provide insurance against a fall in the price of the underlying asset - if you intend to sell an asset at a date in the future, but you are concerned it may fall in the meantime, you could buy a put option. If your fear proves correct, you exercise your put option, selling the underlying asset for more than the prevailing market value.
- To participate in price movements without buying or selling the underlying asset. If you believe a share price will rise, you could buy a call option. If your optimism proves correct, the value of the call option will increase. To realise the profit, you would close the position by selling the call option back to the market. Conversely, if you believe the price of the underlying asset will fall, you could buy a put option. If your fear proves correct, the value of the put option will increase and you would close the position to realise the profit by selling the put option back to the market.
Equity Options offer you the right, but not the obligation, to buy or sell a particular asset (eg shares) or an index representing such assets at a fixed price on or before a specific date. There are two types of options:
- Calls, the right to buy the underlying asset at a fixed price;
- Puts, the right to sell the underlying asset at a fixed price.
Call options generally rise in value if the price of the underlying asset rises. Puts generally rise in value if the price of the underlying asset falls. When buying either a call or put option, the risk is limited to the premium - you cannot lose more than the premium paid at outset. If the share price does not go in the direction you anticipated, you can simply leave your option to expire without exercising it. Options on individual equities allow you to gain exposure to specific shares. But index options allow investors to gain exposure to whole sections of the stock market in one transaction.
For examples (click here)
All about futures (click here)