What Are Options & Futures?
When traders look for a way to diversify away from the stock and bond market, they often end up trading futures and options. Getting involved in the futures and options market gives you the opportunity to speculate on the price of goods or securities without actually owning them at any point.
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Futures Contract Basics
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When you buy a futures contract, you do not own any physical product or a security. Instead, you agree to buy a fixed amount of a commodity at a certain price in the future. You select a specific date in which the product will be delivered on. When you invest in futures contracts, you do not have to take physical delivery of the commodity. Instead, you can trade the futures contract to someone else and realize a profit over what you originally paid for it.
Option Basics
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An option contract is similar to a futures contract with a few key differences. When you buy an option contract, it gives you the right to buy or sell the underlying security or commodity, but you are not necessarily obligated to do so. By comparison, with a futures contract, you are simply buying something in advance and if you hold the contract, you will take possession of the items. With an option, if you do not exercise it by the date of the contract, it expires with no value.
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Transferring Risk
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The main purpose of these types of investments is to help mitigate risk. Buyers and sellers use futures contracts as a way to minimize price fluctuation. For example, if a seller of soybeans knows that he will have a certain amount produced in the future, he can sell a futures contract on those soybeans. This way, the seller will not have to worry about what market prices for soybeans are when they are ready to sell. Options contracts can do the same thing because they guarantee that the owner of the contract can buy or sell at a particular price. If prices change rapidly before the expiration date, the owner of the contract has some built-in protection.
What is Traded
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When it comes to dealing with the options and futures market, you could get involved with any number of underlying securities or commodities. Futures markets involve many different types of commodities. For example, you could trade futures contracts on gold, oil, soybeans, wheat, pork bellies and corn. Options can be used on any of these commodities or on securities such as stocks. Practically any financial instrument can have an option placed on it by an investor.
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