How to Trade Futures & Options for a Beginner

Futures and options provide an alternative investment to stocks.

Futures and options are not as widely traded as stocks. However, these markets often offer better returns than the stock market because of the leverage involved. If you are a beginner, there are a few things you should learn before trading futures and options.

Things You'll Need

• Trading capital
• Futures broker

Instructions

1. Choose a futures broker. Just as you trade stocks through a stock broker, you must use a futures broker to trade futures. Virtually all futures brokers offer options trading as well, so you should have no trouble trading both markets through the same broker. There are varying levels of service to consider when choosing a broker. For example, some full-service brokers offer individual assistance and trading ideas, while other discount brokers provide basic access to the markets but not individualized trading assistance.

2. Specify information correctly when placing an order. First, specify whether you are going long (buying) or short (selling). Next, identify the commodity, the contract month and the number of contracts you wish to trade. Finally, specify the order type. For example, if you want to buy one September orange juice contract, you would enter the order with a comment alone the lines of: "I want to go long one September orange juice contract at the market." Your market order will be filled at the best available price at the time it is placed.

3. Understand the unique characteristics of options. When trading options, you must specify the commodity market, contract month and quantity desired, just as in the futures market. Additionally, you must name an option type and strike price. Options are divided into calls and "puts." Call options give you the right to go long (buy) at the strike price, while "puts" give you the right to go short (sell) at the strike price. Check an options table to find a list of strike prices for the option you intend to trade.

4. Be aware of expiration dates. Both futures contracts and options expire. In the futures market, you must remember to close out any open positions before their expiration to avoid taking delivery of the commodity. If you allow an option to expire with intrinsic value--one that is "in the money"--you will automatically have a position in the underlying futures market. However, if you allow a worthless option to expire, nothing will happen and you will simply lose the premium you initially paid for it.

5. Understand the effect of leverage. When trading futures, you are making use of significant leverage. The amount of money needed to trade a futures contract is only a fraction of the contract's full value. This aspect of futures trading introduces the possibility of large gains and losses. If a trade moves against you and your trading account falls below the minimum margin requirement, you will receive a margin call and be forced to deposit additional funds or close your position. Try to avoid this by closing losing trades immediately.

References

• Futures Order Types
• Investopedia: Options on Futures