Futures and options are both derivative instruments, deriving their value from an underlying asset or instrument. While each has its own set of advantages and disadvantages, one notable advantage of options is that they provide the buyer with the right, but not the obligation, to buy or sell an asset at a predetermined price on or before a specific future date. This limits the maximum risk for the buyer to the premium paid for the option contract.
On the other hand, futures contracts offer certain advantages over options. They constitute a binding agreement between a buyer and seller to trade an asset at a predetermined price on a specified future date. Although futures may not be suitable for all investors, they can be well-suited for certain types of investments and investors.
1. Leverage
While futures trading might not be the ideal method for trading stocks, it serves as an excellent avenue for trading particular investments like commodities, currencies, and indexes. Its standardized characteristics and substantial leverage levels render it especially valuable for investors who are comfortable with risk. The significant leverage enables these investors to engage in markets that might otherwise be inaccessible to them.
2. Fixed Upfront Costs
Margin requirements for major commodity and currency futures have remained largely stable over the years, providing traders with a predictable framework. While margin requirements may experience temporary increases during periods of heightened volatility, they typically remain consistent from year to year. This predictability allows traders to anticipate the initial margin amount required in advance.
In contrast, the option premium paid by an option buyer can fluctuate considerably, influenced by the volatility levels of the underlying asset and the broader market. Higher volatility in the underlying asset or market generally results in a higher premium paid by the option buyer.
3. No Time Decay
One significant advantage of futures compared to options lies in their lack of time decay. Options are considered wasting assets, meaning their value diminishes over time due to factors like time to expiration—a phenomenon known as time decay. Options traders must closely monitor time decay as it can significantly reduce the profitability of an option position or even reverse a winning position into a losing one.
In contrast, futures contracts are not affected by time decay.
4. Clear and Simple Pricing
Futures pricing follows a straightforward logic. According to the cost-of-carry pricing model, the futures price equals the current spot price plus the cost of carrying or storing the underlying asset until the futures contract matures. Any disparity between spot and futures prices triggers arbitrage activities to correct the imbalance.
In contrast, option pricing relies on the Black-Scholes model, which utilizes multiple inputs and is known for being challenging for the average investor to grasp.
5. Liquidity
Another significant advantage of futures over options is that most futures markets boast deep liquidity, particularly in commonly traded commodities, currencies, and indexes. This liquidity results in narrow bid-ask spreads, providing traders with confidence that they can enter and exit positions as needed.
Conversely, options may not consistently offer sufficient liquidity, especially for those far from the strike price or expiring well into the future.
So which is Riskier?
Risk tolerance plays a significant role, but typically, futures are considered riskier than options. A futures contract entails a binding agreement between a buyer and seller to trade an asset at a predetermined price on a specified future date, effectively locking them into the trade. This inherent obligation makes futures riskier compared to options, where the contract buyer holds the right but not the obligation to execute the trade. Furthermore, even minor fluctuations in the price.
Should You Trade in Futures?
Although the benefits of options compared to futures are widely acknowledged, futures possess distinct advantages over options. These include their appropriateness for trading specific investments, predetermined upfront trading costs, absence of time decay, liquidity, and a more straightforward pricing model. If you want to learn more about trading futures, check out our beginner’s guide here
Selecting a Futures Trading Platform
As investors navigate the selection process for a futures trading platform, conducting thorough research is crucial. However, it's essential to consider specific criteria when making your decision. Here are some key factors to ensure your platform can address:
User-Friendly Interface: Look for a platform that is intuitive and easy to navigate.
Diverse Order Types: Ensure the platform offers various order types to assist in managing risk effectively.
Competitive Pricing: Seek a platform with competitive fees and commissions.
Advanced Functionality: For more experienced traders, prioritize platforms that provide access to application programming interface (API) for algorithmic trading.
Most full-service online brokerages and trading platforms offer futures trading capabilities. However, it's important to request and obtain approval before engaging in trading activities within these markets.
Start Trading with Orient Futures Singapore
Being an Overseas Intermediary of Shanghai International Energy Exchange (INE), Dalian Commodity Exchange (DCE), and Zhengzhou Commodity Exchange (ZCE), when foreign clients participate in internationalised futures contracts in these Chinese markets with us, they have direct access to trading, clearing, and settlement. Our parent company, Shanghai Orient Futures, is the largest broker in terms of aggregated volume across the five regulated exchanges in China.
Orient Futures Singapore also currently holds memberships at the Singapore Exchange (SGX), Asia Pacific Exchange (APEX), and ICE Futures Singapore (ICE SG). Starting August 2023, corporate clients can also gain access to the B3 Exchange through us, opening additional trading avenues.
Expect streamlined processes and an easy-to-use interface designed for minimal latency, accompanied by our team's round-the-clock availability on trading days to provide assistance for all your trading needs.
