Are Futures Riskier Than Options?Are Futures Riskier Than Options
Let’s face it, derivative trading is risky. Period.Derivatives such as futures and options are leverage instruments and by virtue of beingleverage instruments, derivatives inherently carry more risk and exposure than pure andsimple stock trading. Leverage instruments are risky because leverage allows you to domore with the same amount of money than you would normally be able to. Yes, leverageinstruments such as futures and options have the potential to generate over 10 times more profit on the same move on the price of a stock than just buying the stock itself.What most beginners to derivatives trading do not take into consideration is the fact thatleverage is a double edged sword. Just as it could help you generate over 10 times more profits on the same move, it could also incur as much losses should the stock moveagainst your favor. This is also why many beginners to futures or options trading losetheir shirts so quickly and go broke.So, why is futures and options trading still so popular then?Very simply, most beginners with only a small fund and wants to build up a significantfund quickly could not depend on simple stock trading for a start. They need moreleverage and they can afford to take more risk since the amount at stake is usually prettysmall. With this in mind, the only question that remains is, which is safer for beginners?Futures or Options?To determine which is riskier, we need to ascertain certain the qualities that constitutes“Risk”. For derivative instruments, the main qualities that constitute trading risk are:Leverage, Liability, Liquidity and Versatility (fulfillment obligation is usually not aconcern in trading as traders rarely hold till expiration).Liquidity in the stock futures and stock options market is definitely lower than the stocksthemselves but is enough for the trading purpose of retail beginners and shall be excludedin this discussion.
Leverage of futures and options is the multiplication effect on your money versus buyingthe underlying stock itself. We shall not go into detailed discussion on how leverage is being calculated for futures and options here. It suffices to know that the higher theleverage, the higher your potential profits and losses becomes. Leverage in futures is a lothigher than the leverage in stock options due to the much higher lot size and low marginrequirement. This makes futures trading riskier than options trading in terms of potentiallosses due to leverage.