Futures and options are financial instruments used to hedge against market risks, but they differ in several ways. In this article, Leeloo Trading explores the advantages of choosing futures over options.
Futures v. options – what's the difference?
While options provide the right, but not the obligation, to buy or sell an underlying asset at a set price and time, futures provide a contractual obligation to buy or sell an underlying asset at a fixed price and time.
Read more here on what's traded in the futures market.
Advantages to trading futures over options
Liquidity
Futures markets are highly liquid, meaning many buyers and sellers are often willing to trade at any time.
This liquidity allows futures traders to enter and exit positions quickly and at a fair price.
Additionally, the high volume of trading activity in futures markets can help to reduce bid-ask spreads, which is the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept.
Lower bid-ask spreads can reduce the cost of trading and improve profitability.
Standardization
Another advantage of futures over options is standardization.
Futures contracts trade on regulated exchanges and each contract has standardized specifications for the underlying asset, delivery date and contract size.
This standardization makes it easier for traders to compare prices and trade with each other, and reduces counterparty risk.
In contrast, options contracts can be customized to meet individual traders' needs, making it more challenging to find a willing counterparty.
Profitable investment
Trading futures can offer a potentially profitable investment opportunity for traders looking to take advantage of market volatility.
Using leverage, traders can control a significant amount of the underlying asset with a relatively small investment.
This allows futures traders to potentially earn a significant return on their investment if the market moves in their favor.
However, traders should be aware of the risks involved, as leverage can also amplify losses and market volatility can cause prices to fluctuate rapidly.
Trading futures successfully means employing some essential strategies for traders, as well as having a solid risk management strategy in place.
Here's how active traders can manage their risk: 7 useful tips.
Lower trading costs
Futures trading also tends to have lower trading costs than options trading.
One reason is that futures contracts have standardized specifications, making it easier for brokers to handle and execute trades.
Additionally, futures contracts are traded on exchanges, so traders can avoid the higher commissions and fees associated with over-the-counter (OTC) trading.
Lower trading costs associated with futures can help traders to improve their profitability and reduce their overall trading expenses.
No time decay
A final advantage of futures over options is that there's no time decay.
Time decay refers to the gradual erosion of the value of an options contract as it approaches its expiration date.
This erosion in value can make it more challenging for traders to profit from options trading.
They need to be correct not only about the direction of the underlying asset's price movement, but also about the timing of that movement.
In contrast, futures contracts do not suffer from time decay, which means that traders can hold positions for as long as they want without worrying about the impact of time on the value of their contracts.
Like the sound of futures trading? Leeloo's here to help! Here's how to get started in futures trading today: a step-by-step guide.
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