Traders’ ought to choose futures when their confidence is high regarding the directional movement of the underlying and choose options otherwise. That said, it is not uncommon for experienced traders to prefer futures over options. This week, we discuss why and when you can choose to trade only futures.

Delta game

Many novice traders prefer options because the trading capital required is less compared with that of futures. Also, such traders believe that risk associated with options is small. But that is not necessarily true. Long option positions can quickly turn into large losses when the underlying moves in the adverse direction.

This is because an option’s delta and theta will work against the position. Delta refers to the change in the option price for a one-point change in the underlying and is a large value. Theta (time decay) refers to the loss in the time value of an option with each passing day. Short options lose money because an option’s delta and gamma works against the positions.

If you are a disciplined trader, initiating futures position can be gainful. This is because the delta of futures is greater than the delta of options. This makes futures position optimal for directional bets — when you have a view that the underlying is likely to move up or down.

True, you are likely to incur more losses on your futures position than options when the underlying makes an adverse movement. But you can moderate your losses if you take your stops. Your stops should be fixed such that you give yourself enough room to stay in the position and yet not risk too much of your trading capital; tight stops may result in frequent losses because your position is likely to get stopped out more often.  

The added benefit of futures position is that you can generate gains even if the underlying moves slowly and reaches its price target only at contract expiry.

For, unlike options, futures contracts do not suffer from time decay. You will lose marginally on your futures position if the price target is reached at expiry and not before. This is because futures price will converge with its spot price at expiry, but can trade higher than the spot price any time during the life of the contract.

Of course, the capital required to trade futures is greater than that required for options. But you must not decide on the choice of instrument based on your trading capital. Your choice must depend on the confidence level on the directional movement of the underlying or on your discipline in sticking to your trading plan.

Why futures
The added benefit of futures position is that you can generate gains even if the underlying moves slowly and reaches its price target only at contract expiry
Optional reading

You should still initiate option positions when you are betting on sideways movement in the underlying; you are betting on an option’s implied volatility imploding (decreasing). So, as a disciplined trader, you can typically bet on futures for all directional trades and on options for capturing time decay and volatility implosion.

The author offers training programmes for individuals to manage their personal investments

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