Trading in the financial markets provides a wide range of tools that enable traders to get more out of their capital as well as manage risks. Some of the most popular trading instruments include futures and options contracts. However, unlike trading options, futures usually come with greater risks associated with it. To succeed in this market, you need to know these details.
Risks of Trading Futures Compared to Options
Let’s look into the risks of futures trading compared to options:
The first cause of increased risk for the future is leverage. Margin deposits of a certain percentage of the contract value are required to trade in futures. This can lead to an additional cost for traders.
On the other hand, option premiums tend to be much lower than futures margins. The maximum loss for an option buyer is very restricted to the premium paid.
This limited downside risk makes options less risky in comparison to futures, where losses can exceed the initial margin and result in margin calls, requiring additional funds to maintain positions.
Futures contracts expose traders to ongoing market risk. These positions are marked to market daily, meaning gains and losses are recorded at the end of each trading day. This daily settlement process often results in frequent margin calls and requires continuous monitoring of positions.
But, options do not require everyday settlement because one can hold till expiration without adjustment thereby reducing constant supervision needs for it.
3. Potential for Unlimited Losses
Future trading can result in unlimited losses. If the market moves significantly against a futures position, the trader can lose more than the initial investment and any additional margin deposited. This unlimited loss potential is one of the most significant risks associated with future trading.
In contrast, the loss potential for options is limited for the option buyer. The worst-case scenario for an option buyer is losing the premium paid for the option. While option sellers (writers) can face significant losses, strategies such as spreads can be used to limit this risk.
Overall, the inherent structure of options allows for better risk management compared to futures. For those interested in navigating these strategies, finding the best broker for option trading is crucial to optimize risk management and maximize potential returns.
Futures contracts require the holder to buy or sell the underlying asset at expiration, exposing traders to higher risks. If the market moves against a futures position, the trader must either accept the loss or add more margin to maintain the trade.
On the other hand, options traders can simply let an unfavorable option expire worthless, limiting their loss to the premium paid. This flexibility in options trading greatly reduces the risk of catastrophic losses compared to futures.
5. Market Liquidity and Slippage
Another factor contributing to the higher risk in future trading is market liquidity. Futures markets can experience periods of low liquidity, leading to slippage. Slippage is the difference between the expected price of a trade and the actual price at which the trade is executed. Slippage can result in higher trading costs and unexpected losses, especially in volatile markets.
While options markets can also suffer from liquidity issues, the variety of strike prices and expiration dates available can provide traders with more flexibility to manage their positions and minimize the impact of slippage. Additionally, the presence of market makers in options markets often helps in maintaining liquidity and reducing the bid-ask spread.
While both futures and options trading come with their own set of risks, futures carry inherently higher risks. Understanding these differences is crucial for traders to make informed decisions and manage their risk effectively in the financial markets.