Picture this—though you have been trading stocks you are still relatively new to trading. You buy shares of well-known stocks like Apple (NASDAQ:AAPL) or Amazon (NASDAQ:AMZN) and sell them for profit.
While you have been doing this, along the way you have heard that there are people who trade futures and options. If you are new, and in this example you are, you probably asked yourself “What are options and what are futures?”
To make this very clear I will first define what stocks are, then (stock) options, and lastly futures. After this, I will talk about the advantages and disadvantages of trading them. Ok so let’s talk stock!
What Are Stocks?
A stock (also known as equity) is a security that represents the ownership of a fraction of a corporation. This entitles the owner of the stock to a proportion of the corporation’s assets and profits equal to how much stock they own. Units of stock are called ‘shares.’
Though there can be private sales as well, stocks are bought and sold predominantly on stock exchanges and are the foundation of many individual investors’ portfolios.
These transactions have to conform to government regulations which are meant to protect investors from fraudulent practices. Historically, they have outperformed most other investments over the long run.
What Are Stock options?
A stock option is a contract to either buy or sell stock at a given price at a future date and time. In some cases, you might have the right but not the obligation to buy or sell a stock.
Options contracts are in 100 share increments meaning you control 100 shares at a time. There are two types of options: puts, which is a bet that a stock will fall, or calls, which is a bet that a stock will rise. These are highly leveraged instruments that allow an investor/trader to control many shares at a fraction of the cost.
What are futures?
Now that we have defined stocks and options, let’s look at futures. Futures are derivative financial contracts that obligate the parties to transact an asset at a predetermined future date and price.
The buyer must purchase or the seller must sell the underlying asset at the set price, regardless of the current market price, at the expiration date.
Underlying assets include physical commodities or other financial instruments. Futures are even more leveraged than stock options and can be very volatile. They are good for intra-day trading.
What are the key advantages and disadvantages?
Ok, so what are the key differences and advantages. The advantages of stocks are that you actually own something (part of the company), you collect dividends, and get a chance to vote at shareholder meetings.
Advantages of options are that they have leverage and allow the retail trader to trade big. They also can trade defined risk positions and have more flexibility in their trading. They can sell credit or premium and make money in an up, down and sideways market.
Lastly, futures are the most liquid and have crazy volatility. This movement makes them the best choice for trading intra-day. They also have the best tax advantages in the US where the first 60% of proceeds are 10% flat tax. If you are trading for income, futures are the way to go.
My overall assessment is that stocks are best for long-term investments with a buy-and-hold strategy. Options are best for retirement but implements a swing trading strategy. Futures are best for trading for everyday income.