subject: Futures And Options - The Optional Investment Future [print this page] Trading in futures and options is considered to be risky and that is why there is a lot of government regulation in this area. There are rules governing both investors and brokers and the rules are intended to insure everyone understands their rights and responsibilities. This is not intended to scare anyone away from investing in options but only to provide a realistic assessment of these types of trades.
The bottom line is that an investor must understand the nature of options investing. When you buy stocks directly, you know exactly how much you can lose which is the equivalent of the price of the stock and any fees or commissions paid. Futures and options present the possibility of unlimited loss because market prices can suddenly swing in the wrong direction leaving someone with an obligation to sell with no control over the amount of loss.
That is why investors are given a Risk Disclosure Statement when opening an options account. If you read this document and do not understand all the terms or the extent of the risk then you are not ready to trade in options. On the other hand, there is unlimited profit potential in options trading. If you do understand how the risks and how the market operates, then you now have a great opportunity to make some money.
Preparing to Invest
The National Futures Association offers some wonderful advice to investors concerning what they should consider before investing in futures and options. The NFA is concerned primarily with commodity futures and options but the organization's advice applies across the board. Following is a summary of the NFA pre-investment checklist along with some additional suggestions.
- Make sure the investment firm you choose as your broker is properly registered and certified. Any company that is involved in options trading must be registered with the Commodities Futures Trading Commission. Stock firms are registered with the Securities and Exchange Commission. You should not try to complete options trading based on the advice of any organization or person who is not properly registered. Futures and options sellers must also be members of the NFA.
- Understanding options pricing is important. Buying options is not the same thing as buying the underlying asset. You are buying a right to buy an asset based on a moving target - market price. It is important to understand how to manage that moving target in relation to the strike price of the option.
- Different brokers charge different commissions and transaction fees. You should shop around, so to speak, and compare the commission rates of different brokers to make sure you are not being overcharged.
- As mentioned, you should read the Risk Disclosure Statement carefully.
- Make sure you understand the risks in the futures and options you want to purchase.
- You should only invest money that you can afford to lose in the worst case scenario.
- You should not believe a lot of hype from various investment firms promising that you will make a lot of money. You should not allow anyone to pressure you into buying options. No investment in any market comes with a 100% guarantee and that is true for options also.
When you are trying to decide which underlying asset is of interest, it is also important to study the particular market for that asset. If you don't know a thing about soybean futures then buying options in soybeans is not wise.
Investing in futures and options requires a mixture of financial savvy and good old-fashioned common sense.
