September 7, 2022

Futures and Options: What are They, and How to Trade Them

Introduction

Learn about some of the more esoteric ways to invest with Strabo

Introduction

Futures and Options: What are They, and How to Trade Them Learn about how to get started with futures and options, and what you should think about when including them as part of a responsible portfolio allocation.

If you're not already familiar, futures and options are two of the most common types of financial contracts. Essentially, they allow investors to speculate on the future price of assets or protect themselves from potential losses. They are often considered to be at the risky end of the investing spectrum, not least because they can have leverage associated with them. In this blog post, we will discuss what futures and options are, and how to trade them. Of course, the primary thing to consider here is risk management - these are non-standard financial assets, and need to be treated as such.

It is important to note before going further that speculative financial instruments are not for everyone. In fact, for the vast majority of public investors these should be nothing more than an esoteric interest or passing fancy - you are not going to get rich trading options. Let's say that again: you are not going to get rich trading options. Please be careful with your money. They can make up some of either the "fun" or "alternative" parts of your portfolio, but should stay at that. At the end of the day, enjoyable habits are habits that you stick to, and so why shouldn't investing be fun? Allocating a small portion of your assets towards risky bets is a way of keeping the "gambler" in you at bay, and introducing some fun into your investing journey. Read more about portfolio construction here. That being said, trading options is a great way of engaging in a more problem solving style of business, which can be fun for many an investor.

What are futures and options contracts and how do they work?

Ok, onto the good stuff. Firstly, what on earth are these things? Well, a futures contract is an agreement to buy or sell an asset at a predetermined price at some point in the future. This asset is often an equity. For example, you might agree to purchase a futures contract for one hundred stocks of Strabo Financial Ltd at $60 per share. If the price of the share rises to $70, then you would make a return of $10*100 = $1,000. On the other hand, if the price falls to $50 per barrel, then you would incur a loss of $1,000, as you'd have to pay to buy them at $60.

Options are very similar to futures in that they are also agreements to buy or sell an asset at a predetermined price at some point in the future. However, with options, the buyer has the right, but not the obligation, to purchase the asset. For example, you might purchase an option for 100 shares of Strabo Financial Ltd. at $60 per share. If the price rises to $70 per share, then you can exercise your option and make a profit of $1,000, as before. However, if the price falls to $50 per share, then you are not obligated to purchase the asset and so you would not incur a loss. You would have only lost the cost of the unexercised option, which would be a fraction of the price of the share. In this regard, options have much more, well, optionality, and therefore carry the same amount of upside potential with much less of the downside risk.

The option to purchase an asset at a future price is known as a call option, whereas the option to sell an asset at a future price is known as a put option. From an accounting perspective, options and futures are fairly similar: a bet on the future direction of a price. The difference comes to the customer at point of use, and the level of margin that is used. Valuation methodology is also something that differs between assets.

The benefits of trading futures and options

As you might have deduced, futures and options are a great way of making a bet on the future direction of the price of an asset. The fact that they are much cheaper than buying the asset itself means that you can use leverage to make a much larger profit (or loss) in the specified time period. One of the key reasons for this is that futures and options are traded without actually being exercised: you take the profit implicitly, rather than having to actually buy the shares on your own personal balance sheet and resell them.

Now, this is great because it means that you don't need a huge capital reserve available to make profit. Of course, the downside of this is that you have the ability to take on a level of leverage, and therefore risk, that is far in excess of your capacity.

How to trade futures and options

Futures and options can be traded on futures exchanges, such as the Chicago Mercantile Exchange (CME) or IntercontinentalExchange (ICE). These work in a similar way to stock exchanges, in that you place an order with a broker to buy or sell at a certain price. Your order is then matched with another order from another trader and the trade is executed.

It's also possible to trade futures and options over-the-counter (OTC), which means that the trade is not executed on an exchange but rather bilaterally between two traders. This is generally only done for more complex products, or where there is a lack of liquidity in the markets.

Conclusion & Tips for beginners when trading futures and options

If you're thinking of getting into futures and options trading, then there are a few things that you should bear in mind. Firstly, always use a stop-loss order to limit your downside risk. This is an order placed to exit a position and limit your losses on any one trade before they get too large. Secondly, don't put all your eggs in one basket: diversify your portfolio across a number of different assets to mitigate the risk of large losses. You can trade futures and options in not just equities, but also the foreign exchange market, and other assets. However, it's best not to just invest in these instruments but also gain access to securities through the spot market, or simply straight up making purchases of these assets. These can be done not just in one currency, but across different countries to spread delivery of risk through different markets. Retail investors now have access to much more than they used to in terms of assets, and their current prices are just one variable to consider. Know your strategy and stick to it - in low interest rate growth environments, it is easy to let this slip.

Finally, futures and options are complex products and so it's important to do your research and understand exactly what you're trading before entering into any positions. Yep, we know we keep banging on about it but it's important. The trivialisation of complicated financial products can also serve to oversimplify them, which makes them even more dangerous. There are a number of stock trading platforms which offer this service and many don't provide the adequate risk warnings to inform new users what they're getting involved in.

Futures and options are complex financial instruments and their prices can be volatile. As such, they may not be suitable for all investors. Before trading futures or options, you should carefully consider your financial objectives, level of experience, and risk tolerance. You should also consult with a suitably qualified financial advisor if you find yourself in any doubt.

Why Use Investing Apps in the UK

The UK has seen a boom in investing apps in recent years, which offer beginner investors an easy to use and accessible option to get into the market.

Investing is now simpler than ever thanks to these applications, which get rid of the need for pricy brokers or complicated procedures. Investing apps like Trading 212, Freetrade, and Revolut make it possible for young and beginner investors to take control of their investments with their user friendly interfaces, built in educational tools and minimal or no costs.

As the need for low cost investing options and financial independence continues to grow, the UK is expected to utilise mobile investing tools even more in 2025. More people in the UK are using apps to manage their money as a result of its adaptability, simplicity of use, and the growing trend towards digital financial solutions and increased awareness of personal financial planning, which makes investing apps an effective tool for beginner investors.

Benefits of Using Investing Apps for Beginners

There are a number of advantages to using investing apps for beginners, particularly for those who are just getting started. Here are a few main benefits:
  • Accessibility - By providing a straightforward, mobile friendly platform that is available at anytime and from any location, investing apps have completely changed how individuals invest. You no longer have to spend hours learning complicated systems or setting up sessions with financial experts. Beginners can begin investing directly from their smartphones with a few taps. Anyone, regardless of their schedule or location, can participate in investing without any obstacles thanks to this immediate access.
  • Low cost - The affordability of investment apps is one of their most notable benefits. The high commissions and administration costs associated with traditional broking services make it challenging for those starting out to invest small amounts of money. On the other hand, a lot of investment apps provide cheap fees or commission free trading, which makes them perfect for beginners. This enables beginners to invest without fear of losing a significant amount of their profits to fees, allowing them to give more money to the market.
  • Adaptability - Traditional investment strategies are not as flexible as investing apps. Beginners can more easily dabble without making a significant upfront payment because many investment platforms enable users to invest in a variety of assets, stocks and shares, exchange traded funds (ETFs), and specialised investment options, allowing beginners in the UK to diversify their investment portfolios right away. Furthermore, everyday investors may manage their investments on their own terms and are not restricted to a 9 to 5 schedule thanks to the option to trade at any time and from any location.
Investment apps are a great place for beginner investors to start because they combine low-cost solutions, user friendliness, and convenience to help gradually increase wealth.

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Key Features to Look for in an Investment App for Beginners in the UK

It's crucial to search for features that can features that can facilitate your learning and make investing simple and accessible when selecting an investment app as a beginner. Here are some essential features to look out for:
  • East to use interface
    The design of the app should be simple and intuitive. You will find it easier to comprehend and utilise the platform without feeling overwhelmed if it has a straightforward and uncomplicated layout.
  • Educational Resources
    The best investment apps include educational materials such as FAQs, videos, tutorials, and articles. Beginner investors can use as a guide to understand important investment strategies and make wise choices.
  • Platform fees
    A lot of investment apps charge management fees and trading fees. To protect your investment gains, it's crucial for beginners to select an investment app with little to no costs. The best investment apps waive management fees or provide zero commission trading.
  • Low minimum investment
    For beginners who might not have a large initial investment, apps that let you start investing with small amounts of money are excellent. Also look for apps that sell fractional shares, so you can invest in pricey stocks without having to purchase the entire share.
  • Portfolio diversification tools
    Seek for investment apps that provide a variety of investment options, including mutual funds, index funds, and exchange traded funds (ETFs). Even with little money you can create a diversified portfolio by making a fractional investment in individual stocks.
  • Robo-Advisor Features
    Some investment apps include robo-advisors which automatically manage your investment portfolio according to your goals and risk tolerance. For those whose may not feel comfortable choosing their own investments, this is a fantastic benefit.
  • Security features
    It is important to ensure that the app has strong security features like encryption, two-factor authentication, and safe account recovery methods to protect personal data and information.
  • Current market data
    The best investment apps have real time market data, charts and stock market performance metrics which are essential for beginners who wish to remain informed and make wise judgements.
  • Type of investment accounts
    There are many types of investment accounts available, such as investment accounts for minors, individual retirement accounts and individual taxable accounts. You should choose an investment app that provides you with a range of account options that can help meet your financial objectives.

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