Expanding your investment horizons beyond simple stock and bond investing can open up new opportunities to profit, hedge risks, and gain valuable flexibility in your portfolio. By understanding and utilising derivatives like futures and options, retail investors can now access advanced strategies previously only available to institutions.
In this article, we’ll explore the benefits of adding futures and option trading and provide practical tips for getting started.
What Are Futures?
Futures contracts allow investors to agree to buy or sell some underlying asset at a predetermined price on a set expiration date. Futures trade on exchanges like stocks and can be used by individual investors for speculation, portfolio protection, or gaining exposure to commodities. Choosing the right platform is crucial for investors looking to optimise their trading strategies. Platforms like m.Stock not only simplifies trading but also provides significant cost benefits.
What Are Options?
Options give investors the right, but not the obligation, to buy or sell an asset at a set strike price up until the expiration date. Calls provide the option to buy, while puts give the option to sell. Investors pay a non-refundable premium upfront for this flexible right. Options can be used on stocks, exchange-traded funds (ETFs), and stock market indexes.
Benefits of Adding Futures and Options
The benefits of adding futures and options are:
1. Hedging Risks
Investors can hedge against stock losses in a declining market by buying put options or shorting stock index futures. These derivatives can provide downside protection as part of an overall risk management strategy. To trade in futures and options seamlessly, it is essential to have a trading account, which enables you to access and execute these derivative transactions efficiently.
2. Speculation Opportunities
The inherent leverage in options allows investors to benefit from short-term price moves in the underlying asset. Futures also provide speculators with opportunities to profit from commodity market moves.
3. Diversification
Futures and options give investors exposure opportunities beyond stocks and bonds, allowing improved portfolio diversification. Commodity futures can counter stock volatility.
4. Leverage Benefits
The premium paid upfront for an option controls the total risk while providing leveraged exposure to the underlying asset. Investors can benefit from significant price gains with a smaller upfront investment.
5. Income Generation
Options strategies like covered calls allow investors to generate income from existing long stock positions through the premiums received from selling call options.
Strategies for Using Futures and Options
Mentioned below are the strategies to use futures and options:
1. Hedging With Futures
Investors can lock in future prices today by buying or selling the underlying commodity futures contract. For example, farmers use futures to fix a selling price for their crop before the harvest season.
2. Protective Puts
Put options allow stocks to be hedged against potential declines at a fixed cost. Puts limit downside risk while allowing investors to keep their long stock positions.
3. Bull Call Spread
Buying call options while simultaneously selling higher strike call options caps costs but allows participation in upside rallies. This can be used to speculate on bullish price sentiment.
4. Bear Put Spread
Put spreads involve buying put options and selling the same number of closer-dated or lower-strike puts to offset part of the upfront premium cost. This structure benefits from bearish declines.
5. Covered Calls
One of the most conservative income strategies involves selling call options against existing long stock positions. Investors get paid the call premium in exchange for limiting potential stock gains above the strike price.
6. Cash Secured Puts
Put options can be sold against cash reserves to generate income from the premiums. The cash acts as collateral in case the puts are exercised below the strike price, allowing investors to buy into stock positions at potentially lower prices.
7. Arbitrage Opportunities
Savvy investors can exploit small price discrepancies between related futures contracts and the underlying asset’s spot price. These futures-cash arbitrage trades aim to lock in small, risk-free profits.
Conclusion
Investing in futures and options offers unique benefits, such as hedging risks, speculating on prices, income generation, and improved diversification compared to simple stock and bond investing. Retail investors can tap into these sophisticated tools by starting small, pursuing continuous learning, and working with licensed advisors to improve their overall returns.
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