Options on stocks vs. options on futures
When I started with options trading, I began with options on futures. The reason for this was that in my very first book about options the author wrote about options on futures. And as I was new to options, it was just a coincidental beginning of mine. But later I found out that the mass of options traders are trading with options on stocks rather than with options on futures. When I noticed this, I was frankly surprised but kept trading options on futures. Meanwhile, I am trading almost only with options on stocks. But not because it’s a better trading in general but just because it’s a more suitable trading for me personally. For all you, folks, who would like to know more about trading with options on futures I wrote this article to give you a first brief overview about it.
|Pros of options on futures
|A much better skew than in options on stocks – which means you can get for calls and puts the same premium. In some commodities you can even get more premium for calls than for puts. In total, sometimes this can mean more trade opportunities than in the stock market.|
Less correlation. In the stock market there is a strong correlation. When we trade options on stocks, more or less all bigger stock markets are linked to each other. In a bull market like we had in the year 2017, it was fun to trade options on stocks. In other years like in 2018, it was more difficult to find an increasing stock worthwhile to sell options when the most stocks were moving downwards.
A price movement in wheat, on the other hand, does not necessarily affect the price of coffee. Or when there is a stronger correction in the stock markets, there would be usually no affection on cotton, and so on.
|In general, you will get a higher premium for an option on futures than for an option on stocks. Especially for bigger accounts (>$50.000) this is an advantage. Because of a higher premium, you need to open less trades and could save a bigger amount of commission fees by getting the same premium (in a long run).|
|Implied volatility is not affected from the movement direction. In stocks, the implied volatility increases usually when the stock is falling. An exception is during the earnings period which happens 4 times a year. But in my opinion, this does not count because the implied volatility rises slightly after the earnings announcement and crushes just after the announcement. In futures, the implied volatility can rise and fall independently from the moves of the underlying which gives additional trade opportunities.|
|Cons of options on futures|
|Different leverage. Every underlying of a future has a different leverage size. Sweet Crude Oil (CL) has, for instance, a leverage of 1000 which means your option on CL covers 1000 barrels of oil. British Pound (BP) has a complete another contract size which is £62500. Different leverage means also different margin requirements. For a newbie, this circumstance could be intimidating and could also lead to mistakes.|
|Higher initial capital required. Ideally, you would have $25000 for serious options trading on futures. Some traders are even recommending an account size of $50000. But at least, you should bring up $15000 which should your minimum account size. The reason for this is not because of a higher risk but because of usually higher contract size than in stocks (I am not speaking about monster stocks like Amazon & Co.). This leads to higher margin requirements and from time to time higher losses because you usually would get a higher premium by trading options on futures. And a higher premium means higher loss limits within your trading system.|
|Different expiration times between options and futures in contrast to stocks. When you take an option on futures, you need to deal with different expirations between options and futures. Besides that, there is also a difference between a lifespan of a future, and it’s expiration. For instance, an August contract on crude oil expires in July. But although it expires, this future would still exist as a name and would finally vanish in August. For beginners, this might be confusing.|
|Cash settlement. When you trade with put options on stocks and your stock lands in the money, you’ll get this stock assigned. In futures, on the other hand, you will just get the money withdrawn. For as a private trader, you will never get physical delivery of any commodity. Therefore, you need to be a good trader, not just regarding your trading skills but also regarding your trading psychology.|
Summary and conclusion
Are options on stocks better than options on futures? I can give you a clear answer – no, they are not. Although options on futures seem to be more complicated than options on stocks and riskier, the advantages are speaking for themselves. Especially, in terms of implied volatility and the skew, every sustainably successful options trader on stocks should also consider to trade with options on futures.
But to be successful in trading options on futures, there are two main requirements you need to fulfill. At least, that was what my experience taught me. And I’m not speaking about money management or risk management. For these skills you would also need in trading with options on stocks.
The first requirement is that you need to be good in reading chart patterns. In other words, you need good skills in technical analysis. The reason for this is, in my opinion, that futures are based on cash settlement for private traders I mentioned above.
When you sell a put option on a stock and the stock would land in the money, you would get assigned this stock and could sell it later when the price of the stock would rise. In case of futures you would need to get the commodity (like wheat, gold, crude oil, etc.). But this wouldn’t be practicable. At least, I don’t think that there is someone who would be comfortable with a delivery of 1000 barrels or more of crude oil.
Therefore, to avoid physical delivery to private traders, you would just get the money withdrawn from your account. But to avoid just to get money taken from your account, you would do much better by understanding technical analysis and increasing the probability of success.
The second requirement is that you need to learn the behavior of the commodities. In other words, you need to understand them. Each commodity has its “own life” and doesn’t always follow the rule of other commodities. In other words, there is not always a significant correlation between the futures, or commodities.
Natural gas, for example, shouldn’t be traded in the most volatile months. The implied volatility would be the highest there and would be very enticing to open a trade. But believe me, this could end very bad. I know this because I lost a lot of money on such a trade in natural gas in my early days of options trading.
And not only me, there were also some professionals who even lost all of their money on natural gas. The most famous among them was for sure James Cordier from the hedge fund “OptionSellers.com”. James Cordier was a professional options trader and he is also the author of the book “The Complete Guide to Option Selling“*. Although this fund does not exist anymore, the book has still a good learning quality. Because it was not the book but the author himself who did not follow his own rules. Irony of fate…?
To make a conclusion: if you are sustainably profitable in trading options on stocks, you should try to extend your activity by trading options on futures to profit from the benefits you got explained above, folks.
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