Five advantages of futures over options

Both futures and options are derivative instruments, meaning they derive their value from an underlying asset or instrument. Both futures and options have their own advantages and disadvantages. One of the advantages of options is obvious. An options contract gives the contract buyer the right, but not the obligation, to buy or sell an asset or financial instrument at a fixed price on or before a predetermined future month. This means that the maximum risk for the buyer of an option is limited to the premium paid.

But futures have some significant advantages over options. A futures contract is a binding agreement between a buyer and a seller to buy or sell an asset or financial instrument at a fixed price in a predetermined month in the future. Although they are not for everyone, they are well suited to certain investments and certain types of investors.

Key insights

Futures and options are commonly used derivative contracts used by both hedgers and speculators on a variety of underlying securities.
Futures have several advantages over options: They are often easier to understand and value, have higher margin usage, and are often more liquid.
Still, futures themselves are more complex than the underlying assets they represent. Make sure you understand all the risks involved before trading futures.

1. Successful investment

Futures may not be the best way to trade stocks, for example, but they are a great way to trade certain assets such as commodities, currencies and indices. Their standardized features and very high leverage make them particularly interesting for risk-tolerant private investors. The high leverage allows these investors to participate in markets that they may not otherwise have had access to.

2. Fixed upfront trading costs

Margin requirements for key commodity and currency futures are well known, having remained relatively unchanged for years. Margin requirements may be temporarily increased if an asset is particularly volatile. However, in most cases they remain unchanged from year to year. This means that a trader knows in advance how much must be deposited as an initial deposit.

On the other hand, the options premium paid by an options buyer can vary significantly depending on the volatility of the underlying asset and the broader market. The more volatile the underlying asset or the broader market, the higher the premium paid by the option buyer.

3. No time decay

This is a key advantage of futures over options. Options waste assets, meaning their value decreases over time – a phenomenon known as time decay. A number of factors affect the time expiration of an option, one of the most important being the time to expiration. An options trader must pay attention to time decay as it can significantly impact the profitability of an options position or turn a winning position into a losing position.

Futures, on the other hand, do not have to contend with time decay.

4. Liquidity

This is another big advantage of futures over options. Most futures markets are very deep and liquid, especially for the most commonly traded commodities, currencies and indices. This results in tight bid-ask spreads and gives traders confidence that they can enter and exit positions as needed.

On the other hand, options may not always have sufficient liquidity, especially for options that are far from the strike price or expire far in the future.

5. Simple pricing

Futures pricing is intuitively easy to understand. Under the cost-of-carry pricing model, the futures price should be equal to the current spot price plus the cost of transporting (or storing) the underlying asset until the futures contract matures. If the spot and futures prices do not match, arbitrage activity would occur and resolve the imbalance.

Options pricing, on the other hand, is generally based on the Black-Scholes model, which uses a number of inputs and is notoriously difficult to understand for the average investor.

Which is riskier: futures or options?

A lot can depend on your risk tolerance, but in general futures are riskier than options. A futures contract is a binding agreement between a buyer and a seller to trade an asset at a fixed price in a predetermined future month, meaning that the buyer and seller are bound to the trade. This is inherently riskier than an options trade, in which a contract buyer has the right, but not the obligation, to enter into the trade. In addition, with futures, even small price fluctuations in the underlying asset can have an impact on trading.

Which futures are traded most frequently?

The most commonly traded types of futures are agricultural, energy, metals, currency and financial futures contracts.

Can you buy commodities without buying futures or options?

You can still buy or sell commodities without trading futures or options by purchasing commodity-heavy mutual funds or exchange-traded funds (ETFs). These funds include stocks, futures and derivative contracts that track the movements of the underlying commodity.

The conclusion

While the advantages of options over futures are well documented, the advantages of futures over options include their suitability for trading specific assets, fixed upfront trading costs, lack of time decay, liquidity, and a simpler pricing model.

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