stock options versus futures

In the financial markets, traders and investors often debate the merits and risks associated with different securities. Two of the most commonly compared are Futures and Options. Understanding the differences between these two can help traders decide which suits their trading style and risk tolerance.

In short, Options contracts allow traders to trade but not the obligation. In essence, investors have the right to buy or sell Options shares at certain prices at any period if the contract is in effect. On the contrary, Futures trading requires a seller to sell shares and buyers to buy them on a specific date unless the holder closes his position before it expires. Therefore the transaction is solid and must go through since with Futures you are often dealing with physical commodities (corn, gold, oil). There is no backing out when it comes to Futures, the transaction must go through at the expiration date. This is partly why oil prices went negative during the COVID-19 pandemic.

While both Futures and Options are financial products to make money, their markets are widely different and pose considerable risks. This article considers the differences between these two financial products to help you make a better-informed trading decision as an individual investor.

Futures: Defined and Demystified

Futures contracts are standardized agreements to buy or sell an asset at a predetermined price at a specified time in the future. These contracts are legally binding and typically involve commodities, such as agricultural products, energy resources, and metals. However, Futures are also prevalent, including those based on market indices.

Futures contracts are time-oriented. They expire, forcing you to make certain decisions, such as selling the contract to take your profits or losses, staying out of the market, or taking the delivery of the equity, product, or commodity the contract represents.

Most Futures contracts can be traded from Sundays, 6 PM (EST) to Fridays, between 4:30 PM and 5 PM (EST) – depending on the commodity. Technically, trading stops for thirty to sixty minutes daily. So essentially Futures are traded 24 hours, which can add to individual investors' stress and workload. Where your sleep may be severely hindered.

What Are the Risks of Trading Futures?

Simply put, Futures contracts can lead you to huge debts. While other traditional financial products, such as bonds and stocks, are associated with high-end risks, Futures undoubtedly generate high yields but even higher possibilities of extremely severe losses. Futures allow for significant leverage, meaning that a small margin deposit controls a large amount of the underlying asset.

In essence, Futures expose investors to maximum risk, just possible to potentially lose all your money within the twinkle of your eye. You have to put some money down when buying a Futures contract, and your rewards and costs aren’t established until such a contract expires. It is not until then that both involved parties discover their outcomes. What does this infer? You have “almost zero” control over your risk profile.

Futures prices are accounted for daily, meaning a certain amount of money is transferred between the seller and buyer at the end of the day. If the prices are unexpectedly volatile, you may be required to add additional funds at the end of each trading day, so you don't get margin-called. 
So, you either will have to have a massive account or be heavily leveraged. 

Lastly, the Futures market is traded on a relatively thin volume, as not many people can afford to trade it. As a result, it is heavily prone to manipulation by hedge funds and other trading entities. You will often see a huge crash or weird price action, wondering what just happened, only to find out a month later it was manipulated by a firm under investigation. This really makes it difficult for the individual investor to be successful.

These three issues listed above make trading Futures extremely dangerous for retail investors. If you don’t have just enough assets to cover your losses, you can end up losing both your trading portfolio and personal finances.

Understanding The Basics Of Options

Options, like Futures, are also risky. The Options contract is based on the value of underlying assets, like stocks. As mentioned earlier, an Options contract offers the opportunity to buy and sell assets at a certain price but not the obligation. In essence, you don’t have to buy or sell an asset if you don’t want to. As a derivative investment form, even when you buy or sell shares, it doesn’t represent the actual ownership of the underlying investment until you finalize the agreement.

Is Options Trading Risky?

The technicalities associated with Option trading risks is that it is relative. This means, that not all Options contracts have the same risk. As a buyer – otherwise called holder – you have a different risk than if you are the seller – otherwise called the writer.

You can continue reading more about Options contracts and the associated risks.

The Bottom Line – Futures or Options?

Both Futures and Options offer unique opportunities and risks for traders. Futures contracts may be suitable for those looking for a straightforward, high-leverage way to trade commodities and financial instruments. Options, with their ability to structure varying degrees of risk and potential return, can be attractive to traders with a more nuanced market outlook or those with a lower risk appetite.

However, with one wrong move when trading Futures contracts, your account may be wiped and maybe even plummet you into enormous debts for your entire life. Technically, it’s not worth the risk. 

Ideally, you should stay away from both!