The Absolute Beginner’s Guide to Understanding Futures and Options
Statistics show just over half of Americans invest in the stock market. Those who don’t invest might not realize it, but they’re leaving profits on the table.
There are many understandable reasons why someone might not invest. For example, low-paying jobs leave many Americans without enough spare cash to invest in the market. Others might feel they don’t know enough about the market.
However, you can at least control your knowledge of how the market works. Why not learn what you need, so you can make wise investments when you have the funds to do so?
As you learn about the stock market, you’ll come across information about futures and options. Not sure what that means? We can help.
Keep reading to start understanding futures and options!
What are Futures and Options?
First, the basics: what are futures and options?
Basically, futures and options are both types of derivatives. A derivative is a type of contract with a value based on a certain asset. These underlying assets can include stocks, commodities, currencies, bonds, and more. The value of the underlying assets changes the value of the derivative.
While these two things often get discussed together, they’re not the same. Let’s look at each one separately first.
Futures refers to a kind of contract that means you’ll need to sell your asset at a fixed price in the future.
People use predictions of the price direction to make investments involving futures. For example, if the value of an asset seems likely to go up, it makes sense to be the buyer in a futures contract. The seller will have to sell the asset at the fixed price even if the actual price of the asset has gone up.
If the value of an asset falls, though, the sale of a future benefits the seller. They’ll get the fixed, higher price no matter how much the price of the asset drops.
Companies often use futures contracts to sell their products and buy what they need. This helps them plan ahead by knowing exactly what price they’ll buy and sell for in the future.
However, traders can also buy and sell futures contracts without ever actually coming into contact with the underlying assets themselves. They’ll profit off of price fluctuations, but the nature of the assets themselves doesn’t matter.
With an option, buyers aren’t obligated to sell or buy at any point in the contract—they simply have the option to do so. With futures, the buyer is obligated to buy at a set date, and the seller is obligated to sell at that set date for the agreed-upon price.
There are actually two kinds of options contracts: put options and call options.
A call option provides the buyer a right to buy an asset at a certain price, called a strike price. Options have a set expiration date after which the right to buy expires.
A put option gives the right to sell, instead of buy, at the strike price. These differences make options function much differently from futures, even though they’re often mentioned in the same breath. People with options contracts can choose not to exercise their right to buy or sell.
Future and Options Trading Basics
Want to get started in futures and options trading? Then you’ll need to know the rules of the game. Here are the basics that will help even beginners get off to a good start.
Because the two are different, you’ll need a different strategy for each one. Let’s take a look at how to get started.
To start with stock market futures trading, you’ll first need a broker who works with the markets you want to trade in.
Your broker should go over your investing experience with you (make sure to tell them you’re a beginner!). You’ll also need to let them know about your financial situation, such as your net worth and income. Brokers use this to help decide what kinds of risks you should take on.
Ask your broker how their commission and fees work since this varies from person to person. It’s also a good idea to start off with a virtual account so you can practice your strategies before there’s real money on the table.
You do need to have strategies. Although your broker will help, devote some time to learning about futures trading and the market in general. You’ll learn as you go, so don’t freak out if you have some losses early on. Losses are normal, and if you panic every time they happen, you’ll make worse decisions than if you take the news calmly.
People often trade in options for the same reasons they trade in futures. You’re making a bet based off what you think the future market activity will be. If you’re right, you’ll make a profit. However, options trading tends to be riskier than futures trading.
Again, you’ll need to work with a broker. However, the application for options trading tends to be more complex because you actually risk losing more than what you paid for an investment.
Your broker shouldn’t start you out with the riskiest trading strategies. Still, it’s important to understand what you’re getting into. Brokers will require you to give them more trade permissions than with other types of investments.
However, once the permissions are in place, trading options look a lot like trading stocks. Again, work on your strategies and study the market so you can learn as you go.
Are Futures and Options Right for You?
Futures and options trading isn’t the right choice for everyone. But if you’re comfortable with the risks involved and willing to learn and develop your strategy, this can be a good way to start trading (or expand your trading strategies).
Interested in other investment options? Check out the latest news on gold markets here.