Difference Between Stock Options and Futures Options

Obviously, there is a difference between stock options and futures options, and the primary differences are in flexibility as well as overall risk.

Let’s first review what futures contracts are as opposed to stock options. Futures contracts are standardized contracts that guarantee to buy or sell a specific commodity of standard quality, at a particular date in the future. This sum will be at market price. Contracts are traded on what are called future exchanges. So right away we can tell that futures contracts are not direct like stocks or bonds. They are still considered securities, but with a different type of contract.

Price for futures contracts is determined by what is referred to as instantaneous equilibrium, that takes into account basic supply and demand as well as competitive buy and sell orders on the market. The asset here may not necessarily be commodities; it can be anything from securities to intangible assets or even stock indexes. The future date is referred to as the delivery date. The settlement price refers to the official price of the contract at the end of a trading day.

1. One significant difference between futures contracts and stock options is that futures give buyers an obligation to fulfill delivery according to the contract’s terms, and the obligation for the seller to deliver the asset as agreed. The only escape here is if the holder’s position is closed before the expiration date. Whereas stock options are flexible by their nature, futures contracts require obligation. Futures are known as exchange-traded derivatives, as the exchange company’s clearinghouse plays the part of counterparty on all of the futures contracts.

2. Another major difference in these two contracts is the way in which gains are received. In options trading, a gain can be realized by exercising when the option is deep ITM, or by going to the market and taking an opposing position, or by waiting until the expiration and then collecting the difference in prices (in this case asset price and strike price). However, when it’s time to collect gains on futures positions, you will notice that these gains are “marked to market”, which means the change in the value of positions will be automatically handled at the end of every trading day.

3. Volatility is also traded differently. With equity options volatility makes the price of the option go up, in the futures it is the opposite.

4. Futures options also have many more strike prices than normal equity options.

5. Volume can also vary from option to option just generally many more equity options are traded than futures options.

What is an Exchange Traded Fund (ETF)

An Exchange Traded Fund (ETF) is a type of investment fund that is traded on stock exchanges.  This type of fund is similar to stock, and holds assets at about the same price as the net asset value.  

The first ETF in the business was introduced in the early 1990s and were called Spiders (SPY).  This ETF tracked the S&P 500 index.  The Qubes (QQQQ) came a few years later and this tracked the 100 largest non-financial companies on the Nasdaq. Some of the biggest players in the ETF market today include State Street Global Advisors, Barclay’s Global Fund Advisors and Vanguard.  Of course there are many types of ETFs, and they can track everything from the United States stock market to just parts of the stock market, like large or small stocks or specific industries.  ETFs even track foreign markets, individual countries, and commodities.

 There are hundreds of ETFs to choose from.  An Exchange Traded Fund combines the valuation feature of mutual funds (the same kind that can be bought or sold at the end of each day for a net asset value) with a tradability feature of a closed-end fund (the type that trades throughout the day with prices different than the net asset value).  Closed-end funds are not actually ETFs even though they are all traded on an exchange. 

 ETFs offer investors a chance at undivided interest (with simple and lucrative operation like traditional mutual funds) with a little bit extra protection: ETFs can be bought and sold every day like stocks, just as you would find with a broker-dealer.  Another difference is that Exchange Traded Funds do not sell or redeem shares at net asset value.  Therefore, financial institutions purchase and sell ETF shares in large blocks, which can run anywhere from 25,000 to 200,000 shares.

 ETFs offer other advantages such as easy diversification, lower expense ratios, and better tax efficiency (due to their index fund-like operation).  ETFs are less expensive than other financial products because of the lack of management and because of fewer expenses in meeting shareholders purchases and redemptions, as well as lower marketing costs.  They are also very flexible in terms of buying or selling.  Because they are publicly traded, shares for ETFs can be bought on margin and sold short.  Investors can also take advantage of hedging, stop orders and limit orders. Options are also traded on most major ETFs.

 You may want to look into the flexible and potentially lucrative market of Exchange Traded Funds, especially if you are just starting to invest your own money.  They may look and act like stocks but they give you a whole world of opportunity, as they combine the best features of many different types of funds. 

 As ETFs become more and more popular several mutual funds and hedge funds are beginning to have ETFs are part of their portfolios.

Should You Be Buying Gold?

Is Gold a bubble or the trade of a lifetime?

Maybe both.

I have not been in the gold trade myself. But several of my members are, and doing very well so far.

Here is a chart provide by one such member. It shows that the stock of gold companies, miners, etc continue to appreciate evn though gold prices peaked earlier. If this hold true this time, even if gold has peaked, which it does not look like it has, the miners will continue to rally.

Last week a member emailed saying that it looked like GLD had topped out and would I consider selling calls. My answer: No Way.

This train still has momentum on its side as you can tell from the rally today. What I did do on Friday, was to buy a debit spread in GLD.

I bought the Jan 115 Calls and Sold the Jan 118 Calls. I paid about $100 per spread and am already up 17% today. Not bad, but I expect it to go higher and with Jan expiration I can wait for a couple more weeks to see what happens.

Where do you think Gold is headed?

How Much Money Should You Use For Option Selling

Hi,Like most people I have various accounts. The account in question is what I normaly “traded” out of. This is not my retirement account but an account to hopefully help build wealth not preserve. Historically I’d say I only used 5% of it toward option plays (and not whole 5% in one position) since I usually was naked and a 100% loss was possible. I haven’t been trading much of anything lately but do you feel your strategies are designed safe enough to utilize 100% of this type of account? I guess what I’m asking is once somebody says yes they are utilizing risk capital would you suggest devote entire sum to these type of plays or should some percentage still be in other growth tactics? Asking because I’m trying to simplify my life at this point, not make it more complicated.-Paul

I am not licensed to give specific advice. But I would think that you should not put 100% of your money into anything. Especially if you are un familiar with it.  What I tell new members is to paper trade for a couple months, then start small. Once they get the hang of th etrades and the ups and downs, then they can add more capital to the trades or even do their own trades.

I would suggest the same for you. I use these trades for a large part of my income but I do use other trading strategies as well.
 
Allen

Market Commentary

I frequently get asked which way I think the market is headed. Especially after the event of recent days where the markets have been on a sprint to the upside but with pull backs the last couple days.

I usually respond the same way every time.

“I don’t know.”

If I could predict the market I wouldn’t be here blogging, I would be out enjoying my billions.

Believe me, I have tried to learn how to predict the markets. That’s what technical and fundamental analysis is – an attempt to understand and predict market direction.  In the end, I gave up.

I cannot predict market direction. The pundits on TV and radio can’t do it, all the blogs and gurus online with their fancy explanations, charts, candles, lines, and waves can’t do it with any regularity and neither can the folks on Wall Street.

So why bother?

Why not trade in a way where it doesn’t matter which way the market moves?

Makes sense to me. And that is why I love option selling.  It does not matter what is going on in the market, what news comes out or doesn’t, the premium I sell loses value everyday, and I profit.

Let me give you an example. This month I have a McDonald’s (MCD) trade on. I want MCD to stay within a range. A couple days after I put the trade on, MCD moved higher and almost out of the range. So I adjusted the trade and made the range bigger.

That day a member emailed me with news that there is a rumor going around the MCD is going to raise its dividend. That might be why it went higher. And if the news about the dividend is correct, it might go higher still.

This member wanted me to know that this trade was not a good idea. He was warning me to what could happen. Thanks to this member, who had my best interests at heart, I began to worry about this position.

What if he was right and MCD shot up higher?

But after a while I calmed myself down and realized that it was not in my hands. If MCD went higher I would evaluate the position, adjust if possible or in the worst case scenario take a small loss. But the odds were on my side.

As it turned out, MCD has behaved fine since and the trade is right in the middle of the profit zone. Let’s hope it stays that way.

But my point is that it does not matter if the dollar is stronger or weaker. It does not matter what oil or gold do. The markets still move in ranges and if you play the ranges, 8 times out of 10 you will win. And those wins allow you to make much higher returns that you will in a savings account, a CD, a money market fund, or a mutual fund.

Why You Should Own Microsoft (MSFT)

Microsoft is a huge company and you probably already have their stock either in your personal portfolio or in any mutual funds you may have. Lately MSFT has not been doing much. But I think that is going to change.

For a stock to move it needs a catalyst, some reason that will make it jump or fall. This could be earnings, bad news, new sources of revenue, etc.

For MSFT the catalyst comes in the form of a software upgrade.

I have a friend who one a successful custom software development company. As a software developer he was given an advance copy of Windows 7, Office 2010, and the new version of some developer software.

I have never seen him get so excited about software that he has not written himself. He told me that Windows 7 was awesome, and that every developer that uses Microsoft will upgrade to the new developer software and those that do not use Microsoft will switch.

He even gave me a short demo in Windows 7 and it looked nice. Not being a techie I did not get as excited but it sure looked better than the XP I use now.

Because of these new releases, I feel that MSFT is a buy from now until at least 2 earnings announcements after the release of these products. As the launch comes closer, the stock will rise until the release, and then dip until earnings. If sales are good, the stock will rise on earnings for at least 2 quarters.

But there is another play here. There are many individuals like myself and IT buyers at large companies that are waiting to upgrade their computers after Windows 7 comes out. There is no sense in buying a new computer now and having to upgrade the software in a few months.

So even if Windows 7 is not a blockbuster, I feel that new computer purchases will be on hold until it releases and that means you can get into stocks like HP, DELL, and INTEL now and ride them higher as sales go up because of the Windows 7 release.

Lessons from Bernie Madoff

In another post, I commented how I do not feel very sorry for the “victims” of Bernie Madoff. No one forced these people to give him their money. They did so out of greed. Yes, he was a con-man and the system should have caught him long before, but if they want to blame anyone, they should look first in the mirror. Especially those that gave him all of their savings.

Am I a monster? Hardly. I feel bad for the people who are in hard times through no fault of their own. Like the story I just saw on NBC about the family in Fort Meyers Fl who bought a condo in a new development. With more than 300 units in their building, they are the only occupants. All the other units are empty. The builder has cut off power to most of the building, maintenance, and security.  The builder has offered to move them to the next tower, but their lender, Chase, said they would not transfer the mortgage to the new unit. These people are stuck with no money to move somewhere else and no way to sell their current condo. That’s a horrible situation to be in.

This recession had taught everyone a lot of lessons. I just hope that we all do not forget them. Let’s review some of what we learned from Madoff.

1. Never invest all your money in one place. I know that Warren Buffet says to put all your egss in one basket and then watch the basket very carefully. But he also says to only choose the basket after doing very complete research. Most people don’t have the time to do the type of research Buffet suggests. So spread the money around. Stocks, bonds, metals, selling options, real estate, cash and others.

2. Know where your money is. Many investors gave their money to a hedge fund which invested with Madoff. In this case they did not lose everything. But even still they should have known where their money was. Ignorance is no defense.

3. Understand your investment and investing. I sell options. And with options you can have very nice above average returns. But there is also the possibility of loss. Above average loss. Before you buy or sell anything, you must know what it is, how it works, what your risk is and when and how you will get able to get out.

For example, when someone becomes a member of my site, I tell them to paper trade along with me for at least a couple months. I have had members lose money on trades because they entered their orders incorrectly. If they had paper traded they would probably not have made such elementary errors.

Many of my members are attracted to my site because of the better than average gains. But some of them tell me they want better than 10% a month returns. Others feel that 10% monthly is a decent return. These people are living in a fairy tale. 10% a month is AMAZING! Hedge fund managers would sell their first born for one year with 10% monthly returns. Yet some members think that it is only decent.

4. Be in control. I feel you should be able to get your money out of an investment when you want. This is called liquidity. Only invest in liquid markets. Even if you are new to real estate investing: you should only invest in properties that can be sold relatively quickly.

If anyone appraoches you with an investment in which your money is tied up for months at a time, make sure you can afford to lose that money. Because you just might lose it all.

5. Stay on top of it. Remember that you have worked hard your entire life for the money you have. But earning it is not enough. It is time for your money to work for you. For that to happen, you must be financially educated enough to know how to make it grow.

If you are a reader of my blog you are already more financially savvy than 90% of the population. Kudos to you.  But there is always more to learn. Stay on top of your investments and they will take care of you.

Ignore your investments and you will end up giving them away.