When it comes to investing, some are in it for the long haul, others for the quick kill. The former look for opportunities with solid future prospects, which, when it comes to the stock market, means they are looking for companies with proven strength and a sunny outlook going forward.
For the latter, though, these speculators look at other things. For the most part they care little what business a company is in or who’s in charge in the executive suite. They’re just looking to make a buck on the movement of the stock price itself.
Futures trading is one such strategy
And when it comes to the stock market, that means stock options. Not the kind given to execs as performance perks, but the kind that are traded as contracts on listed options exchanges.
Options are nothing other than futures, in the same way that commodities futures trade on the future outlook of pricing on things like corn and pork bellies. These option contracts are bought and sold in large quantities, and at a blinding pace.
The price is solely dependent on the price movements of the underlying stock.
Puts and Calls
There are two primary futures contracts available on stocks, called puts and calls. Both can be shorted, giving investors literally hundreds of combinations and alternatives when it comes to playing the price movement of a stock in either direction.
It’s like gambling. Only in this game, some investors are betting on the stock to go down.
With options, somebody makes money and somebody loses money whenever the price of a stock moves. Up or down, it doesn’t matter.
Because that movement directly impacts the market price of the option contract associated with that stock, only with significantly more leverage.
If a $10 stock goes up $2, that’s a 20 percent increase. But with that same $2 movement, the price of the call option associated with that stock may double or even triple overnight. If the stock goes down $2, the price of the put contract will go through the roof.
Such is the game of futures trading with puts and calls
A put is a contract to sell 100 shares of a given stock at a fixed price, within a certain length of time. When the price of the stock falls, the value of the option increases, since the holder of the contract at expiration will be able to sell it at the higher fixed strike price of the contract. The lower the market price, the higher the profit.
A call is a contract to buy 100 shares of a given stock at a fixed price, within a certain length of time. When the price of the stock goes up, the value of the option increases, since the holder of the contract at expiration will be able to buy it at the lower fixed strike price of the contract. The higher the market price, the higher the profit.
Futures trading is all about price movement, which means it relies on technical trading data and market trending as much as it does fundamental information about the company or its market. However, the latter is an influence on price movement of the stock itself, so this becomes a consideration when looking at a futures contract that extends up to nine months.
Beginners Beware
Futures trading, whether in stocks or commodities, is no place for the uninformed or the timid. But if you have the risk tolerance, the leverage here makes for a fast and potentially lucrative strategy.
And if you are the seller of options (against stock you own), it can actually hedge your bet and protect you from the downside. This becomes a conservative futures strategy, one that can be combined with buy-side options to create a complex set of investment tools.
