Futures Options are financial contracts that are often overlooked by traders, but due to their unique characteristics, the advantages of options trading might be worth looking into. As a trader you can utilize futures options as a trading tool for a long term outlook on physical (Gold, Crude Oil, etc) and financial futures (Stock Indicies, Bonds, etc ).
The Options 101
The buyer of an option has the right, but not the obligation (in contrast to futures and spot trading), to buy or sell the underlying asset (such as a commodity or a stock) at a certain price on, or before a certain date.
The buyer of the option pays a fee for the option (the premium) to the seller. The strike price of the option is the price at which the option can be exercised at. Options have an expiration date, which means that if they are not exercised before a certain date, they expire worthless.
For example, Crude Oil currently trades at $60, but you expect the price to go above $62 within the next weeks. You can buy a Crude Oil call option with a strike price of $62 and an expiration date in 4 weeks for $1 ($1,000 cost premium+ Commissions) today. If Crude Oil does not go above $62 before the expiration date, the option expires worthless and you lose the premium you paid, which is $1 per call option.
On the other hand, if Crude Oil goes to $65, you can exercise the call option and you can buy Crude Oil for $62, although it is currently quoted at $65, which is a $3 (3,000 profit per contract -Commissions) . The upside potential for buying call options is, therefore, unlimited theoretically, whereas the potential loss is limited. The specific calculation above was used with crude oil where $1 move is equal to $1,000 (1,000 barrels in a contract).
The 4 basic scenarios when buying and selling put or call options are displayed in the following table.
Anticipated Direction |
Potential Profit |
Potential Loss |
|
Buy Call Option |
Bullish sentiment | Unlimited, if the underlying asset appreciates. | Limited to the paid premium of the option. |
Sell Call Option |
Bearish sentiment | Limited to the premium you receive from the buyer of the call. | Unlimited, if the underlying asset appreciates. |
Buy Put Option |
Bearish sentiment | Unlimited, if the underlying asset depreciates. | Limited to the premium you pay for the option. |
Sell Put Option |
Bullish sentiment | Limited to the premium you receive from the buyer. | Unlimited, if the underlying asset depreciates. |
The 5 advantages of options over futures trading
There are 5 major benefits of trading options, which could help traders overcome the most common problems when trading futures or spot.
1 – Reward:Risk ratio
The potential reward:risk ratio can be very high due to the unique characteristics of options. The potential losses when buying calls and buying puts are limited to the premium paid, whereas the upside is almost unlimited when buying calls and puts.
A common problem among futures traders is that they do not use stop loss orders, use mental stops that are not executed with discipline, or continuously widen their stop loss order when the trade goes against them. When buying options, the risk is predetermined and it is limited to the premium paid.
2- Short-term volatility
Another common obstacle for futures traders is that short-term volatility often “kicks” them out of potentially profitable trades. When unexpected news are released, or an event surprises the financial markets, short-term volatility can increase significantly, which can often the cause that stop loss orders are reached, just before the price reverses back into the original direction.
If you have bought a call or a put, volatility only has a limited impact and, especially important, your option will remain valid even if the price moves against you substantially; the greatest limiting factor in options trading is time.
3 – Trade idea is good, but the timing is wrong
This advantage is a consequence of the previous point. Often, traders are better at picking the broad market direction, but their timing and their stop loss placement is off, which then results in unprofitable trades although they can see that price eventually made it to their initial take profit. When buying options, the entry timing of trades has a smaller impact and the influence of stop loss orders is not present at all, but knowing the broad direction is more important.
4 – Emotional problems
Revenge and over-trading are among the most commonly made emotionally caused trading mistakes and they are the result of inferior coping mechanisms when it comes to realizing losses. Traders often personalize losses and after a loss still believe that their trade idea is right, which then causes them to open another trade, often without valid entry criteria and purely based on impulsive reactions.
When buying options, the impacts of stop loss orders are removed because the only thing that determines whether you lose or make money, is the price of the underlying asset when the option expires. During an options trade, you do not get direct negative feedback about your position which can potentially remove the impacts of emotionally caused trading decisions to some degree.
5 – Options are multi-directional
Due to the unique characteristics of options and the way their payoff is structured, different types of option contracts can be combined to capitalize on very specific market behavior. For example, a ‘Long Call Butterfly’ allows you to profit even if price does not move much, a ‘Long Straddle’ is not limited to a direction and can make money in both, bull and bear markets, whereas a ‘Long Strangle’ allows you to speculate on rising volatility.
Whereas a futures trader is limited to either trade with buy or sell orders, an options trader can choose from a variety of scenarios and, therefore, tailor his trading methodology around his personal needs, his investing perspective and the trading tools used.
How to Start?
As laid out, options have a very unique set of characteristics and although they are overlooked by a great share of traders, they could enhance the way you approach trading and potentially help you avoid some of the common mistakes that are very pronounced when trading futures.
If you want to know more, Optimus maintains a wide selection of online commodities trading platforms to help you become an effective trader. Or contact one of our friendly staff to talk about your needs and we help you find the best solution for you!
THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN COMMODITY INTEREST TRADING CAN WORK AGAINST YOU AS WELL AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS.IF YOU PURCHASE A COMMODITY OPTION YOU MAY SUSTAIN A TOTAL LOSS OF THE PREMIUM AND OF ALL TRANSACTION COSTS.
FUTURES TRADING INVOLVES A SUBSTANTIAL RISK OF LOSS. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.
IF YOU PURCHASE OR SELL A COMMODITY FUTURES CONTRACT OR SELL A COMMODITY OPTION YOU MAY SUSTAIN A TOTAL LOSS OF THE INITIAL MARGIN FUNDS OR SECURITY DEPOSIT AND ANY ADDITIONAL FUNDS THAT YOU DEPOSIT WITH YOUR BROKER TO ESTABLISH OR MAINTAIN YOUR POSITION. IF THE MARKET MOVES AGAINST YOUR POSITION, YOU MAY BE CALLED UPON BY YOUR BROKER TO DEPOSIT A SUBSTANTIAL AMOUNT OF ADDITIONAL MARGIN FUNDS, ON SHORT NOTICE, IN ORDER TO MAINTAIN YOUR POSITION. IF YOU DO NOT PROVIDE THE REQUESTED FUNDS WITHIN THE PRESCRIBED TIME, YOUR POSITION MAY BE LIQUIDATED AT A LOSS, AND YOU WILL BE LIABLE FOR ANY RESULTING DEFICIT IN YOUR ACCOUNT.
