Futures vs Options: Which Should You Trade?

Trading Strategy Playbook | Lesson 4

There are three main types of derivative contract – futures, options and swaps – but it’s the first two that tend to be listed on exchanges- with swaps tending to trade over the counter – OTC – away from the exchanges. 

Regardless of specific type – the two main uses of derivatives are hedging and speculation and so – whenever hedgers and speculators trade listed derivatives they have a fundamental choice of instrument – futures or options.

• Why might speculators choose options over futures?  Well, the key relationship for any trader is that between risk and reward – and options limit risk – if buying!  When we buy an option – any option – we can only ever lose the premium paid. Of course, the dynamic is very different when selling options – but buying options can significantly limit risk, an attractive proposition for any spec trader.  This feature of long  options – limited risk – also allows specs to gear up and take on bigger speculative positions.

• Hedgers may choose options over futures for the flexibility that their name implies. Hedging with linear instruments such as futures or forwards is widespread in practice but locks hedgers into a price and prevents them from benefiting from favourable market movements. This may in turn place hedgers at a disadvantage to their competitors- a very real problem in a highly competitive world. If hedgers use options instead of futures then they are hedged (protected against adverse price movement) yet still able to benefit from favourable movement in the market. Of course, there is a cost associated with buying options – but this can be reduced or negated by combinations of options – strategies such as collars or fences.

So market participants- whether hedgers or specs – can choose between futures and options.

Futures are undeniably easier to understand than options – but the additional work and understanding required by options is – in my opinion- more than justified by the flexibility that they offer.

Author: Bill Beagles, Head of Training, Professional Trader Qualifications & Development, ZISHI

At ZISHI, we help you develop the skills and mindset needed to navigate today’s markets with confidence. Our tailored training solutions, real-time simulations, and expert-led programmes provide traders at all levels with the practical knowledge to succeed.  Explore a full portfolio of Financial Markets, Financial Products & Trading programmes here.

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Trading Strategy Playbook: Lessons from Trading Trainers

Over the next few weeks, we’ll be sharing key lessons from industry veterans to help traders at all levels sharpen their strategies, improve discipline, and master market dynamics.

Coming Next:

• Lesson 5 | Trading vs Investing
  Trading and investing both chase profit—but the real difference isn’t what you think. It’s time, and that one factor changes everything from strategy to stress.

Here’s a look at the articles already featured in our Trading Strategy Playbook: Lessons from Trading Trainers series:

• Lesson 1 | The 5 most common trading mistakes and how to avoid them
  Most traders fail by making common trading mistakes. Learn the top 5 to avoid—before you make them—with expert insights from ZISHI.
• Lesson 2 | Trading Choices: Selecting the Right Market Instruments.
  Once upon a time, traders had limited options—now, from futures to CFDs and spread betting, the possibilities are endless. But which is right for you?
• Lesson 3 | Speculation—Good or Bad?
  Is it fuelling market liquidity or creating unnecessary volatility? We break down the pros and cons.

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