Unless you know how to use options properly, they will not benefit you, in fact they can hurt you, because you can be right the market and wrong your option strategy and lose money.
Example, if gold is at $650 and you buy a $700 call for $1100 that expires in 6 months and the market goes to $695 on expiration day, your $700 call is worthless, giving you an $1100 loss. If you would have bought the $650-700 vertical call spread for about $1400 instead, you would have made $3100. The naked $700 call had an unlimited pipe dream profit potential, and the spread was more realistic with a limited profit. The $700 call would need a futures price of $747 to make a $3600 profit, but would have unlimited profit above. The spread needs a futures price of $700 to make $3600. The trade off in strategy is clear. Unless you knew this strategy you would have probably bought the $700 call and lost money.
Also unlike a futures contract, the above strategy had a KNOWN risk and TIME frame, which allows you to stay in a trade without the possibility to lose more than you paid for the options. If the futures went down $45 in a week ($4500 loss per futures contract) you might have been stopped out of a futures contract losing $4500 to make $5000 at $700. You are still in the option trade without fear of unlimited losses and still have the time to see if the market could turn around and become a profitable trade. Even though the margin is low for a gold futures contract that does not mean that a 100 ounce futures contract is suitable for a $10,000 account. There are some trade offs but “options are a good option” to futures.
The proper strategy and the discipline to do it is a big part of being successful, without that it could be disaster trading futures with unlimited loss potential on a highly leveraged contract.
Options allow you to use them exactly as you want to fit your thoughts, ideas, and time frame. Using the various strategies you can make money if the market goes no where, explodes up or down, marches in one direction, and even make money if you are partially wrong the market.
Based on your trade thoughts about the underlying futures contract, the option trader must be somewhat of a market strategist to obtain the best results. The more you know, the better your chance for success.
Again I want to stress that you need an understanding of option strategies in order to benefit from option trading.
Options give an advantage to controlling risk that futures alone do not have. Even if you wanted to buy an option for your protection from being wrong the futures contract you hold, that would be two trades, two commissions, two entries and two exits, when the same would be accomplished but better with the simple purchase of an intrinsic option. An intrinsic option will act just like a futures contract minus the premium paid if you are right the market. If wrong it can only lose the amount paid for the option no matter how much the market moves against you. Like buying built in discipline to not let your losses run against you. The loss of this premium is usually less than the futures stop loss and buys you the time for a turnaround without the worry of further loss. To me this is well worth it instead of trading a future with a stop. These options will act more like a futures contract with more profit as you are right, and act less like a futures contract and lose less money in relation to a futures contract if the market goes against you.
Imagine if you are caught in a limit move against you with a futures contract instead of an option. Now you are in jeopardy of losing more than you thought because it has opened well past your stop and still cannot get out. This cannot happen when you buy an option. The option losses less percent of its value as the underlying futures price moves against, and gains at a higher rate when you are right. Lose less when wrong, gain more when right
Casino rules
There are strategies that make you the casino and give you the odds instead of being the player and giving up the edge. Example that I use often is, if the S&P 500 was at 154000 and you thought the market was going to be lower than 152000 in 4 weeks, you could be a player and buy the 1540-1520 vertical put spread for about $2450 or be the casino and sell the 1540-1560 vertical call spread for $2450. The difference is that if you buy the put spread you must be right for 980 points to be even and selling the call spread you need not be right and still make $2450 or part thereof. Both bets are even money, but I like to be the casino.
Covered calls and covered puts is another way I use options. They pay me for holding a position. If I was in a long term trade and I want to earn money while I am taking risk holding a position, I look to selling an option at my objective and collect premium. Example, I buy gold at $650 and I want to hold with an objective of $700, I could sell a $700 call option with 6 months until expiration for $1100. I would be making almost $200 a month average for doing so. On expiration the futures would need to be above $711 for me not to have gained more. Anything less than $711 and it was money earned for holding a position. If wrong the market, it will only help losses by the premium collected. If my objective was $750, it would be wrong to sell the $700 call.
Butterfly and condor, call and put spreads, and their variations are some of my favorite strategies. They will greatly reduce the cost of getting long or short a market that has a high cost for the premium or time decay of their options.
I like the fact that with knowledge, options can manage time. Instead of futures that need an exit (stop loss) to control and prevent further losses: therefore lose the right for more time in the trade, the options that you bought cannot lose more than you paid, and BUYS you the time needed to find out if your trade will eventually profit or unemotionally decide that it will not work and exit at that time.
Options are vehicles to take you where you want to go, they do not tell you where the market is going. You are the driver. They are to be driven by your thoughts, ideas, and time frame to allow you to profit if correct.
There are many trade offs between futures and options. When you understand how options work and know the right strategy for the given time frame, it can do more than just avoid some of the pitfalls in futures trading,
Howard Tyllas Copyrighted June 10, 2007
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