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Futures vs. Options.


Hello,

I am interested in covering my long positions (SPY, QQQQ, MDY, etc.) until November-December using futures or put options.

Could someone comment on the merits of each, especially wrt spreads, time decay, trading costs, risk, etc.

I have an account with Etrade where I am able to trade options ($10 + 0.75c per contract). Etrade also offer futures trading ($4/contract) which I can easily sign up for. Average trades would be 3-5 contracts.
Well the basic difference is that with futures, if you have a perfect hedge against your SPY, QQQQ, MDY etc. you will essentially lock the price of your current positions until you remove the future. Your futures short position Profit/Loss will offset the Loss/Profit in your underlying position.

Going long a put option will lock in all profit (at a price - think of it like insurance) but it will allow you to continue to profit if the underlying continues to rise.

You may also have the ability to write a covered call option which would give you give you cash and lock in the price. So in this scenario you would gain if the market remained flat or dropped.

I haven't compared the trading costs so can't comment on that. The risks are as described above. There are plenty of mathematical formulas that can be applied in order to calculate the risks involved with each option but I don't think that's what you're looking for is it?

From experience, the spreads in the futures tend to be tighter than those in the options and that is a pure function of liquidity and applies to any market. i.e. the spreads are tighter in the futures market because they are more liquid and so if the options that you are dealing with are more liquid then the spreads will be tighter. So way out-the-money and way in-the-money options are going to have wider spreads because they are less liquid.

From recollection, time decay is most severe for options that are at-the-money and occurs most quickly (hyperbolically) as the option nears expiration. i.e. time decay accelerates in a non-linear fashion towards expiration and is most noticeable for the at-the-money options.

Time decay works against you if you are an option buyer but for you if you have written options.

Not sure how much that helped you?
Day Trading,

Thank you for your prompt response.

Spreads are one of the main reasons I am looking at futures vs. the options that I am currently employing. Spreads and the time premium. Most ATM options I am interested in (QQQQ, SPY, etc.) have a 3-10% spread. Spreads on the indices (NDX, SPX) are'nt any better. That means I loose 6-20% just in the spread (presuming I buy and sell before expiration, which is what I do often). Not to mention the $40 in trading costs. This is unacceptable to me. I understand futures spreads are much tighter.

Re time decay.....I am presuming that the time decay in futures is much less severe. You are basically paying for the leverage - there is no "insurance". Right?

If that is the case, then presuming you have cash on hand, why not simply short against the box (i.e. short sell 1000 QQQQ's to protect your long 1000 QQQQ position). Why pay the leverage premium and higher trading cost - $40 for 10 futures contracts vs. $7 to short sell?

The other option, if capital gains are not a problem, would be to simply sell the position until you are comfortable with the market and then buy it back.

BTW, do you know of any web site that compares these choices - futures vs. options vs. short selling vs. selling? I am also interested in seeing how much time premium is built in to futures prices and how much money I would loose when rolling over. Do you know of any site where I can get futures prices?

Thank you in advance (again) for your input.
quote:
Originally posted by jeyragusa

Re time decay.....I am presuming that the time decay in futures is much less severe. You are basically paying for the leverage - there is no "insurance". Right?

Correct. The time decay in futures is called the cost-of-carry and is basically the amount of money that you would earn by putting the cash to work by investing it in the money market until the expiration of the future. So say, for example, to buy the same value in futures exposure cost $100,000 and your futures margin is $1,000. Then the $99,000 that you don't have to "tie up" in margin is placed in the money market at the current rate. The amount that you make on the $99,000 is that amount that you will loose as the futures premium closes in to the cash price as the future expires. This premium "decays" in a linear fashion and is easily calculated. You can do this quickly in a spreadsheet by just using today's date and the expiration data and that will give you the number of days to expiration. Then take the current futures premium (over the cash) and divide it by the number of days and that will give you the amount that the premium will reduce by each day.

quote:
If that is the case, then presuming you have cash on hand, why not simply short against the box (i.e. short sell 1000 QQQQ's to protect your long 1000 QQQQ position). Why pay the leverage premium and higher trading cost - $40 for 10 futures contracts vs. $7 to short sell?

If you can do that then you are obviously better off just closing out your QQQQ position rather than hedging it - which I think is the case here. Hedging using futures and options is more effective if the underlying is difficult to sell or move such as a crop that hasn't been reaped yet.

quote:
The other option, if capital gains are not a problem, would be to simply sell the position until you are comfortable with the market and then buy it back.
Exactly. If you can get in and out at low costs and high speed then this is usually the best solution. What you're doing here is switching from a long-term buy and hold position to a swing trader style position where you're moving in and out the market on a weekly/daily basis until you're comfortable with it again.

quote:
BTW, do you know of any web site that compares these choices - futures vs. options vs. short selling vs. selling?

I don't but if you find a good reference page then please post it here for our reference.
quote:
I am also interested in seeing how much time premium is built in to futures prices and how much money I would loose when rolling over. Do you know of any site where I can get futures prices?

That's an easy calculation which I described above. Your loss will be your cost-of-carry and will not be a loss if you're holding a short position and roll that. Just compare the price of the future in the near expiration to the next/following expiration and that will show you the number of points that you will loose over a 3 month period.

Remember that the cost-of-carry is in lieu of having to commit your pile of cash to holding the underlying index and so is not really a loss or time-decay. It's just a re-allocation of resources to a different part of the market.
Day trading said "What you're doing here is switching from a long-term buy and hold position to a swing trader style position where you're moving in and out the market on a weekly/daily basis until you're comfortable with it again."

Exactly. And you are right, futures are not what I need. Actually, buying put options would serve my cause better because if I am wrong and the market moves [significantly] higher, I would still make some money.

I found this site where I was able to get delayed futures quotes:
www2.barchart.com/mktcom.asp?code=BSTK

Thanks for your help dude. You rock!
You're very welcome