Why Trade Futures and Options?
Some of the features that make futures and options appealing investments include leverage, diversification, opportunity, liquidity and price availability.
Futures and options have a unique feature that make them a more attractive instrument from a trading perspective than stocks and bonds, and that is high leverage. Leverage is a measure of the worth or value of an investment relative to the money required to buy (or sell) the investment. For example, if a trader needs to pay the full value of an asset when he buys it, then there is no leverage. On the other hand, if the trader only needs to put up a small fraction of the value of an asset in order to buy it, then leverage is high. Futures are highly leveraged assets since only a little money, referred to as margin, is needed to control a lot of futures value. Typically, a futures contract can be bought or sold with a margin of 2% to 20% of the value of the contract. As mentioned before, with futures, the money or margin required to buy or sell a contract is not a cost but just a "goodwill" performance bond - you get this money back when you close your futures position, plus any gain or minus any loss on the futures position itself.
Futures contracts are also appealing because they can provide diversification to a portfolio of traditional financial assets such as stocks and bonds. Many investors are already aware of the benefits of diversification within their equity portfolios - the more company stocks you hold, the less volatile is the value of your overall portfolio since as some stocks go down, others go up. On average, the portfolio earns a return very similar to the entire market. In the same way, an investment in futures can provide diversification benefits in terms of reducing the overall risk of one's investment portfolio and increasing total profits.
Futures and options are available on a wide range of instruments including agricultural commodities like wheat and soybeans, precious metals like gold and silver, foreign currencies like the Deutschemark and Canadian dollar, interest rates like U.S. long-term bonds and Treasury bills, soft commodities like coffee and sugar, index products on equities and currencies, and energy products like crude oil and natural gas, to name a few. With all of these markets, one is bound to discover a trading opportunity or two at almost any time.
Investors require market liquidity. A market is said to be liquid if transactions can be executed quickly and easily. There are many futures markets that are liquid, sometimes even more liquid than the cash market for the underlying instruments themselves. For instance, the futures market in U.S. Treasury bonds is regarded as being much more liquid than the cash market. In some cases, the futures market is so liquid that futures prices become the industry benchmark. For example, gold, crude oil and cotton futures prices form the basis for pricing other related products in the industry. On the other hand, some futures markets are thin, meaning not very liquid. A trader should know the liquidity of the market that he is trading or wants to trade, and adjust his trading style appropriately. Volume and open interest provide a good indication of market liquidity, the higher are they, the more liquid is the market.
Futures and options prices are readily available from a wide range of sources including the Internet. This makes it very easy for traders to monitor the markets, determine their entry and exit points, and manage their futures positions - all of which provide more reasons to trade futures.