Futures trading offers traders access to stock indexes, fixed income, currencies, and commodities globally. There’s ample liquidity and with low margin rates, so it’s an efficient way to deploy capital or create profitable alpha strategies.
Futures options work virtually the same as normal equity options, but the underlying asset is a futures contract. Interestingly enough, because futures are derivatives, futures options are actually derivatives of derivatives. Meaning, futures options depend on the price of the underlying future, and the underlying future depends on the price of the underlying asset. It might seem slightly confusing, but it’s pretty simple once you get the hang of it.
Futures are exchange traded derivatives. That means they are standardized contracts traded on an exchange such as the Chicago Mercantile Exchange (cme.com) or the Eurex (http://www.eurexchange.com/exchange-en/). Standardized contracts help to increase volume and liquidity and the exchange acts to guarantee against counter-party risk.
Futures contracts include an underlying asset such as the S&P 500 or the DAX 30. A futures contract also includes a contract size. The multiplier on the popular emini S&P 500 futures contract is $50 * the index value. The next feature are the delivery months. Many physical commodities such as oil are delivered monthly, while financial contracts often have a quarterly delivery schedule. Mostly futures contracts settle in cash rather than with physical delivery. That saves you from having to take delivery of 1000 barrels of oil, but before trading any futures contract, go to the exchange website and look up the terms for the contracts.
Advantages of Futures and Futures Options Trading
When you trade futures, you pony up margin to the exchange. The margin is typically 5% of the notional value of the contract, so you can get a lot more leverage in futures than you can in the stock market. Leverage cuts both ways as it can amplify gains, or losses. As with any margin situation, the exchange requires maintenance margin which means you need to put up more margin if your position goes against you.
The other big advantage of futures options trading comes at tax time. Traders pay long-term capital gains tax rates on 60% of their futures trading profits. The other 40% is taxed as short-term capital gains. Still the aggregate rate is lower than you’d pay for trading profits on stocks, or mutual funds or options trades.
Liquidity, plus leverage, plus tax advantages, plus easy access to multiple asset classes, make futures options trading an attractive option for any trader’s toolkit. Read about basic options strategies you can do with futures and equity options on the strategies page.