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Investing in futures and options

How to invest in futures and options?

What are futures contracts?


Futures contracts are one of the most popular derivatives that have been traded on the stock market for many years. On the design side, this is the simplest instrument from your group. It can be stated that futures is a classical derivative.

What is a futures contract?

A lot of the instrument says its name. First, the contract - the contract. Every man has many contracts in his life, such as a contract of employment, a loan agreement, etc.

The contract is always concluded between two persons or entities. The same is true with futures contracts. By investing in a contract, we conclude with another investor an agreement giving us certain rights but also obligations.

Second, futures. For this instrument, the word is crucial. In a futures contract, two investors agree that one of them will buy a certain asset from the other within a certain future date (maturity day or expiry day).

On the stock market these assets may include, but are not limited to, stocks, bonds, currencies, but also stock exchange indices. These instruments are called base instruments.

A very important part of the agreement is the price agreement, after which investors will settle their contract in the future (this price is called the forward price or futures price). Other terms and conditions of the transaction, such as the number of underlying instruments and permitted maturity dates, are set out in the instrument specifications developed by the Exchange.

Compare futures contracts to stocks


The stock market is the so-called. the immediate transaction market. The transaction is settled and settled at the same time. If you want to buy stock, we must hold 100% of the value at the time of placing the order, after which we want to buy shares.

If we want to sell shares, we must be their holders. After the transaction of shares on the buyer's account, the shares immediately appear, and the seller's cash account.

In the case of futures contracts, the conclusion of the transaction (contract) and the settlement of the terms of the transaction take place at different times. At the time of the transaction, we do not have to have cash or a base instrument on our account (the maturity date is required), only the price at which the final settlement will be agreed. The settlement itself is made at the expiry date of the contract.

Term transactions are sometimes made in everyday life. An example might be a farmer's contract with a recipient for future deliveries, even before harvest. If a sale price is specified in the contract, we are dealing with a term transaction.

Futures are an effective way to limit the price risk of a hedging instrument because the price of the underlying is set in the contract. Transaction parties know at what price the transaction will be settled. It is therefore indifferent for them the price of the underlying instrument, which will be formed in the future in the market.

An investor who, in connection with a futures contract, will be obliged to sell the underlying, is called a SELLER. It is also called the CONTRACTOR EXPRESS, as well as the SHORT POSITION.

An investor who, in relation to a futures contract, will be obliged to buy a base instrument, is called BUYER CONTRACT. It is also said that this investor HAD A POSITIVE POSITION.

It should be remembered that the terms of the SALE / SALE of a futures contract indicate the actions that the parties to the transaction will have to execute at the expiry date.

It should also be stressed that the contract is a two-way unconditional commitment of the parties to the transaction to settle it in the future for predetermined terms. This means that we can not withdraw from the contract at the expiry date.

How to start investing in futures contracts ?


Once we have the appropriate theoretical basis, investing in futures contracts starts with the selection of a brokerage house. All brokerage firms available on the market offer their clients access to futures contracts. Of course, the question arises of what office to choose.

One of the most important selection criteria is transaction costs (brokerage commission). In the case of futures contracts, the commission is a fixed rate charged on each contract entered into.

Commission rates vary depending on the office, the way the orders are sent (commissions from internet orders are the cheapest), the turnover you make. If we are an investor with a large turnover then there is a chance of negotiating a lower commission rate at the office.

Of course, we should also look at factors such as the reliability of the online ordering system (whether there have been breakdowns in the history of the broker concerned and how quickly they have been removed) and the usefulness of the system, employee competences, friendly service, or the office it organizes for its investors training, other costs.

If we have already decided on a particular brokerage house, we need to sign an investment account with this office. Then we deposit money into our account (money that will be locked in a security deposit) and we can transfer orders to the Exchange.

But before that, let's make sure that we understand the rules of contract trading thoroughly and that we accept the high investment risk associated with investing in this instrument.

What are the options?


Options are - like the contracts - a very popular instrument listed on the stock markets. Its construction is slightly more difficult than futures. Options can also be classified as classical derivatives.

It's good to know that:

a. options are not difficult

Contrary to general opinion, investing in options need not be difficult. In this market you can create strategies for experienced investors, but also for beginners. The easiest way to invest in options is to buy options. This method of investing is simple and is characterized by the possibility of making very big profits.

b. you can achieve high return rates

By buying options, you can achieve very big profits (on any other strategy you can not earn more). Why is this happening? Since the option price is very volatile, it means that if the underlying price increases, the option price will rise a lot. Therefore investing in options is much more profitable than in stock.

c. you have limited losses

Option is an instrument where you can make a lot more money than to lose. There is no other such instrument on the market. What's important, with options from the beginning, you know how much you can lose.

d. no margin

Investors who trade futures know what a security deposit involves: money surcharges, the need to close down positions, and more and more losses.

By purchasing options, investors do not have these problems. Although options are derivatives, their buyers do not need to keep margin deposits. You can earn as good as on futures contracts, in a much calmer manner.

And now details.

Options, like futures, are an agreement between two investors. Here we also deal with the exhibitor and the buyer of the instrument. The fundamental difference between options and contracts is that the distribution of rights and obligations under this instrument is not identical for the parties to the transaction (as was the case with futures contracts).

We can distinguish two types of options:

call options;
sales options.

Call options provide the buyer with the right to buy the underlying at a predetermined price and under pre-determined conditions. There is a situation very similar to the situation of the buyer of the futures contract, but the difference is that in the contract the investor is obliged to purchase the underlying (even if it is not profitable for him) and, in case of options, the investor has the right to acquire. Do not use this right and base instrument do not buy.

Similarly with the sales options. By purchasing this type of option, we receive the right to sell the underlying. Here we can find an analogy to the procedure of the contract issuer, who also sells the underlying instrument at maturity.

The contract issuer, however, is obliged to join the sale contract at the time of execution of the contract, while the buyer of the put option decides whether to exercise the right to sell or not.

Of course here comes the question of who is the party to the deal with the buyer of the option (buy and sell). It is obviously an exhibitor of the option. In the case of options, we are dealing with the issuer of the call option and the issuer of the put option.

By issuing an option, we therefore agree (at the request of the purchaser) to enter into a buy / sell transaction with the underlying instrument, ie:

• When making a call option, we are obliged (at the request of the buyer of this option) to sell the underlying.

while

• When making a sale, we are obliged (at the purchaser's request for this option) to buy the underlying.

It can therefore be stated that an exhibitor is an investor who grants the buyer the option rights. But of course not for free. You have to pay for the rights. When issuing an option, we receive from the buyer an option of a certain amount of money, which is called an option premium.

Buying an option carries a significant cost element in the form of an option bonus. This was not the case with futures contracts, where we were dealing only with a security deposit.

In conclusion, the option market can take up as many as 4 positions: buy option, buy option and put option to buy and issue option to sell.


Buying options as the easiest way to invest in options


The easiest way to invest in options is to buy them. This is the basic and most popular way to invest in options by investors (mostly individual).

When buying options, an investor receives an instrument with a very favorable characteristics for it. On the one hand, it is possible to make very large profits (which no other option strategy gives), on the other hand - has a limited loss level and its maximum value is known from the beginning of the investment (the maximum loss is the paid option premium).

However, the question arises: which option to invest? There are many in the market. Each series represents other investor expectations. How to choose the right series for us?

The investor must make the following decisions:

a) choice of underlying instrument

The fundamental decision is to choose the underlying. First of all, it depends on the success of our investment. If we choose a base instrument whose value will change according to our expectations, then surely we will earn on the purchased options.

b) type of option

The type of the option indicates what changes in the value of the underlying instrument are expected. If we want to earn on growth, then of course we buy buy options. If we want to make a profit - we buy sales options.

c) execution rate

We already know that this is a value whose overrun by the underlying instrument guarantees a payment at the expiration of the settlement amount option. On the market are options with multiple execution rates - closer and more distant than the current value of the underlying.

d) date of expiration

There are always several dates to choose from. We choose this term for which we anticipate a specific change in the value of the underlying instrument.

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