Sunday, March 10, 2013

When to use Futures instead of Options

If you've taken the path that many retail traders have journeyed you probably started with buying stocks, then options, then futures. If you haven't yet made your way to futures this post is for you. Recently I've been looking through my past trades going back to 2008 before the financial crisis hit and I had just started to trade something other than a covered call. Prior to the end of 2007 and early 2008 I had solely been a covered call writer for about six years. I was looking through past trades to try and get a feel for what I used to trade and how my numbers were so great for so long. In a past post I commented that most of this was luck as I was long and writing calls from 2002-2008. But I found something that contradicts that.

I got bearish in February 2008 and started dabbling in buying puts for the first time. Clearly I didn't know what I was doing and I'll show you why. Below is a screen shot from my trade log.

Though I did great that month as the market was falling, I was actually taking on more risk than needed given my intentions. All I knew what that was I was bearish and wanted to play the market to the downside without shorting SPY or DIA because at the time their prices were so high that a short position took up too much capital. Up until this time all I knew was options, I was still trying to understand futures and wasn't ready to use them with real money until I had a better understanding.

What you can't see in that snap shot is the price of the underlying at the time I initiated the trade. But I can tell you what I was doing. I was buying DIA at about $10 In-the-Money (ITM) and looking to sell when the underlying moved $1, or about 100  Dow points. I knew enough at that time to know better than to buy At-the-Money (ATM) options as if I did that a large portion of my purchase would have been time value. I don't know what VIX was at this particular time but it isn't  important to this post. Even if VIX was at a an all time low and I was essentially paying very little time premium, this was still a case where had I been a better educated investor/trader, I would have been using futures. As you can see from the entry and exit dates, I was looking for very quick strikes. This wasn't meant to be a long-term trade or investment, I was just trying to profit from each 100 points move in the Dow.

Now instead of paying $12.60 for $10.00 worth of intrinsic value, I should have just used options and shorted the YM, or ES if you trade the SPY. This is just another case of me being lucky on direction and cashing out thinking I knew what I was doing. Its real easy to look at your record and think you must be doing something right, that's not always the case. And for me, it wasn't until a few years later that I truly learned how to use futures that the light went off. I clearly remember thinking to myself, "why the hell did you used to buy ITM premium instead of just shorting futures." The honest answer is just that I didn't know any better. While you can make the argument that buying an ITM put carries a defined risk while shorting futures carries unlimited risk, what I didn't mention was that had I been wrong and this moved against me I would have been quick to take my losses and move on. I had no intention of letting it ride and hoping I didn't lose 100% of an ITM purchase. So knowing what I know now, I would have shorted the futures and used a stop order at whatever point I deemed necessary.

If anyone reading finds themselves in that category of crossing over from options to futures and have any questions feel free to comment below and I promise to respond.

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1 comment:

  1. Futures certainly make more sense then options when taking directional trades. Like you mention futures are a much more efficient use of capital than shorting/buying stock. So you get the same kind of leverage using futures as you do stock. You just don't have the same issue of theta decay or volatility contraction (assuming vol is high). I just think one caveat worth mentioning is that like options the position should be sized accordingly with respect to your portfolio size. Too many people make the mistake of putting on more size than they should just because the capital requirement to put on the trade is so low do the the leveraged nature.