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Futures and
options are both derivative instruments, meaning they derive their value from
an underlying asset or instrument. Both futures and options have their own pros
and cons. One of the benefits of options is obvious. An option contract gives
the contract buyer the right, but not the obligation, to buy or sell an asset
or financial instrument at a fixed price on or before a predetermined future
month. This means that the maximum risk for the buyer of an option is limited
to the premium paid. But futures have some key advantages over options. A
futures contract is a binding agreement between a buyer and a seller to buy or
sell an asset or financial instrument at a specified price in a predetermined
month in the future. While not for everyone, they work well for certain
investments and certain types of investors.
1. Fruitful investment
futures may not be the best way to trade stocks, but they are a great
way to trade specific assets, such as commodities, currencies, and indices.
Their standardized features and very high leverage make them particularly
useful for the risk-tolerant retail investor. The high level of leverage allows
these investors to participate in markets they might otherwise not have had
access to.
2. Fixed upfront trading costs
The
margin requirements for major commodity and currency futures are well known as
they have been relatively unchanged for years. Margin requirements may be
temporarily increased when an asset is particularly volatile, but in most cases
they remain the same from one year to the next. This means that a trader knows
in advance how much initial margin to put down. On the other hand, the option
premium paid by an option buyer can vary significantly depending on the
volatility of the underlying asset and the broader market. The more volatile
the underlying asset or broad market, the higher the premium to be paid by the
option buyer.
3. No time decay
this is a key advantage of futures over options. Options waste assets,
which means their value decreases over time - a phenomenon known as time decay.
A number of factors affect an options
expiration time, one of the most important being the time to expiration. An
options trader needs to watch out for the lapse of time as it can severely
affect the profitability of an options position or turn a winning position into
a losing position. Futures, on the other hand, don't struggle with time lapse.
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