April 26, 2019
An approach to these financial products, and the differences between each one.
For everyone interested in financial investments, Options and Futures appear a very attractive way to make money. But, not all the traders are able enough to do it. Operations with these financial instruments require deep knowledge, in order to do it with the minimum risk.
Before knowing how to invest, let´s undertake an overview of the main concepts and definitions of these types of financial products.
To define the concept of an Option or a Future, it is necessary to think about its differences. While both are agreements to buy an investment at a specific price by a specific date, there are several contrasts between them. The first one relies on the obligations that both products put on their buyers and sellers.
An Option provides the right, but not the obligation, to buy or sell shares at a predetermined price at any time, as long as the contract is in effect. On the other hand, a Future contract obligates the two sides to make a transaction.
Another difference is the risk involved with each. The buyers of an Option can lose – at the most – their initial investment known as the option “premium” and any transaction costs. In fact, it is possible to speculate on increasing or decreasing future prices with limited risk. While the purchasers of a Futures contract are obligated to participate in the agreed-upon exchange.
For this reason, the type of investors who prefer each instrument is different. While Speculators are the main target of Future contracts, Options are mainly chosen by hedgers. Where profits are concerned, Futures offer unlimited profit and potential loss instruments, and Options contracts are unlimited profit, limited loss instruments. Also, Futures require a higher margin of payment as compared to Options. The way the gains are received by the investor, is another key difference.
Main Types of Options: Calls and Puts
In case you choose to invest in Options, there are some basics you need to know: Calls and Puts are the main types of Options. What is the difference between Call and Put?
When you Call an Option, you acquire the right, but not the obligation to buy a given quantity of the underlying asset, as long as the life of the Option occurs.
In contrast, a Put Option gives the holder the right to sell an underlying asset at a specified price and a predetermined date.
Basics of Option and Futures Trading
When trading in Options and Futures, there are some basic notions that are worth knowing. Let’s see some of these:
Strike Price: This is the price at which the Futures contract can be purchased. It’s also known as “exercise”.
- Underlying Price or Future Contract: is the principal component that sets prices of derivative securities, warrants, and convertibles.
- Intrinsic Value: when an In The Money Option( IMT) is exercised, it has an amount of money called Intrinsic Value.
- In the money (ITM): when the strike price of a call (put) Option is below (above) the stock price.
- Out of the money (OTM): when the strike price of an Option is above (below) the stock price.
- Premium: is the price paid by the buyer and received from the seller, who puts the cost of an Options contract.
- Time value: It refers to the price of an Option, less the intrinsic value. This concept is also known as Extrinsic Value.
What are the benefits of operations in Options?
Now you are fully interiorized in Options and Futures, maybe you are wondering how convenient the operation in these types of securities is.
One of the most important advantages is the low amount of money requirements. You can start to trade in the Options market with $1000 and make much more than in the Stock market. Also, to buy or “call” an Option has other benefits, like the flexibility and the diversification.
The leverage is a tool which allows you to control large amounts of a commodity with a comparatively small amount of capital. Options allow you to employ considerable leverage, and this is a great advantage, especially for trained traders with a lot of experience using leverage. Another benefit of buying Options is that it allows you to have unlimited upside with limited downside.
On the other hand, consider as disadvantages the lower liquidity and the higher spreads, as well as the commissions.
And, what about Futures?
In comparison with currency forwards, the cost of trading Futures is very low. They also have a low margin. But, keep in mind that it is a speculative product, and another disadvantage is that if you want to earn large amounts of money, you need to be a professional or experienced trader.
Did you know that…
…that the popularity of Options is quite recent. While in 1973 the volume of traded Options was of 1 million, in 2015 it increased to 5 billion.
Are you ready to start trading in Options and Futures?
Remember, it is always convenient to have a trading plan and find a broker that offers low commissions, so you could maximize profit. Find the best fit for your goals, by reading full reviews.
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