How to Trade Futures & Options

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Trading futures and options on the major commodity and stock exchanges is fun and not too complicated, and can be very profitable. All you have to do is open up a stock and option trading account at a brokerage and once you get your account funded, then you are ready to go. Futures trading does require greater liquidity, and you do have to have your account approved to trade futures, but it is not a big deal and you don't have to be rich.

Things You'll Need

  • Computer with Internet connection
  • Internet browser
  • Account at a brokerage (Fidelity, Charles Schwab, etc.)
  • At least $500 to fund your account
  • The first step in trading options and futures is setting up an account at a brokerage house. You can do this by telephone or by mail, but it is very simple and easy to do with a computer with an Internet connection (and ideally you will want to trade from your account at home and not have to rely on calling a broker to make trades). Today, almost all major brokerages offer comparable rates and services, but you should shop around as there are often nice promotions like free trades or a small cash bonus for opening an account.

  • The next step is funding your account. You will have to deposit at least $500 in your account to get started, but it is easy to send your brokerage a check or have them transfer the funds directly from your bank account.

  • The next step is research. That is, research on which stocks/options or commodities/futures you are interested in buying. Every brokerage will have a a complete price history and charting service available so you can see how each stock/commodity has traded in the past.

  • The next step is actually buying the options or futures contracts.

    When you buy an option contract, you are buying a put or a call that represents the right to 100 shares of that equity at the strike price of the put/call. For example, if you buy an IBM December 2010 call with a strike price of $50, then you have the right to buy those 100 shares of IBM at $50 each anytime between now and the expiration in December of 2010. So if the stock price goes up after you buy the call, then your option will also increase in value, but if the stock price goes down, then your call will lose value.

    It is the same principle with futures, except that you are buying a contract to buy a certain amount of a commodity (soybeans for example) at a specific time point in the future, and your futures contract will lose value or gain value depending on the price of that commodity over time.

  • The most important concept to keep in mind with both options and futures is time value. You only have the right to buy that stock or commodity for a limited period of time, and the value of the option or future contract will erode slowly over time even if the price of the underlying stock or commodity stays the same.

    So by buying an option or futures contract you are making a leveraged "bet" that the stock or commodity will go up or down significantly within a specific period of time, and you will make more money than if you had just owned the underlying stock/commodity. However, if there is no significant change or it goes the opposite direction from what you thought, you can lose your entire investment.

Tips & Warnings

  • Start trading options/futures with a "fantasy or model portfolio" (available at almost all brokerages) before trading with actual money to familiarize yourself with the process.
  • It is VERY IMPORTANT to read all of the the options and futures trading disclosures provided by your brokerage. Futures and options trading is risky, and while they are a useful part of an overall investment strategy, they are not conservative investments and can lead to large losses if the markets go against you.

References

  • Photo Credit profit/loss image by Warren Millar from Fotolia.com
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