How to Buy Futures & Options
Futures and options have similar elements that investors should know in order to trade these securities successfully. Futures and options also use considerable leverage which will invariably affect an investor's trading style. The measurement of risk is important. Options provide a controllable amount of risk. Futures do not.
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Instructions
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Open a brokerage account at an online firm that trades both options and futures. You will need to fill out additional forms for margin (the ability to borrow or leverage your account), and to trade futures. Know that you will need minimum levels of net worth and income to qualify to trade futures. Understand that your liability in futures may extend to your personal holdings if a position results in a loss that cannot be closed. Trade option strategies only where your risk is known at the outset of the trade.
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Compute the elements of an option. Use the same structure on a similar spreadsheet for futures. In column one enter the price of the underlying stock. In column two enter the option price. In column three enter the strike price. In column four subtract the strike price from the option price. The result is the option premium. This amount will decline to zero at the expiration date of the option. Enter the expiration date in column five.
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Use fundamental analysis to analyze the general direction of the underlying stock or commodity. Use technical analysis to execute a trade. Because option and futures are time sensitive and use leverage, it is important to enter a trade so that it is profitable quickly. Always use protective stops. Protective stop is the price where you realize your maximum acceptable loss and immediately sell the security. Never let a small loss become a larger loss. Trade with discipline.
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Use technical analysis to trade using stochastic oscillators, moving averages or price and volume charts. See Resources for further information. Understand that trading will probably result in as many losses as wins. Traders make money by cutting losses and maximizing profitable trades.
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Remember that option traders buy puts when they believe prices are declining and they sell puts when they expect the stock price to be flat to up. Trade calls by buying calls when expecting prices to rise and sell calls when expecting prices to be flat to down. Trade futures by being long or short when expecting prices to rise or fall. Trade options on futures prices as you would trade options on stock.
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Buy futures and options with precise money management rules. Decide before the trade how much loss you are willing to absorb. Cut losses so they are never more than 2 percent of the total value of your portfolio. Money management is at least as important as your trading strategy.
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Before trading with real funds, practice your money management and trading strategy by back testing. Back test, or practice trade, using historical data from bull, bear and sideways markets. Understand that the premium calculated in step two is a real loss unless the option or future rises above that price. Rarely will a trader hold an option or futures contract to expiration.
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Tips & Warnings
Futures and options trading are driven by extensive mathematical relationships. Learn the math and terminology or don't trade futures and options.
Never trade without extensive testing. You can eliminate many mistakes by testing a theory in bull, bear and sideways markets.
References
Resources
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