Use of option & Futures in Investment Program

The aim of this paper is to provide a brief overview of how options & futures can be utilized in the investment program. Futures & options both are financial products which are used by the investors for generating income or for hedging the investment that the investors have made. It can be said that both are contracts or agreement for purchasing the investment on a specific date and on a specific price. Options and Futures are different from each other and have their own type of risks for the investors.

Nature of Option Security & uses of Future Securities

            The options and future both are financial products which are utilized by the investors for the creation of money and for minimizing the risk. Options provide the right to the investors to purchase or sell shares on a specific price at any time until the contract is valid. However, it is not an obligation for the investor.  On the future hand contracts is the obligation for the buyer to sell or purchase the shares on specific future time on the agreed price (Hull, 2010).

            In order to understand the futures, the futures should be considered with reference to commodities like oil & corn.  The futures are considered a true hedging instrument. For instance, the farmers can use the future contracts for locking the price so that if the market price of the crop falls before the delivery of the crop, the farmer can get the price on which it agreed upon. The future contracts were actually invented for the institutional purchasers who have the possession of products like oil or corn for distributors. Through futures contracts, such purchasers mitigate the risk of huge price swings.  The futures contracts can be used for investing is such commodities which experience significant price changes in less amount of time (Madura, 2008).

How options & futures can be used to mitigate Risk

There are basically two types of options which include put options and call options.  The call option can be explained as the offer to purchase the stock on a specific price before the expiration date of the contract. The specific price here is also known as the strike price. If the option strategy is used effectively, then the option can be used for mitigating the risk. The call options are usually used by the investors for generating income by using the covered call strategy.  The call options can also be used for managing the tax as well. On the other hand, the futures contracts can be used for reducing the vulnerability of prices.  Through the future contract, if the prices of the invested commodity fall drastically than the investor will get the price on which it agreed upon which means that risk will be mitigated up to a lot of extents (Madura, 2008).

Put & call purchase Strategy of Use of option & Futures in Investment Program

            For example, it has been decided to open a call option for purchasing 100 shares on a $100 strike price in the upcoming 6 months. The stock is trading at $90 currently. In the upcoming 6 months if the price of the stocks reached $110 than the investors should exercise the right to purchase the stock on $100. After purchasing the stock, the investor should sell the stock on $110 price. Through this using the investor can earn $10 profit on each share.  However, if the stock prices trade below $50, and the contract expires, then the purchasers will lose the upfront payment, which known as the premium (Baker & Riddick, 2013).

            The put options, on the other hand, should be utilized when the investor thinks that prices of the stocks might fall in the upcoming months. For example, the investors can sell the put option on $100 price. During this time if the prices of the shares fall up to $70 than the $30 would be the gain which the investor will get from selling the shares. Therefore it can be said that through call option, the investor makes a bullish bet because when the prices of the stock go up the investor earns money. On the other hand, a put option is an actually bearish bet because when prices of stock decrease, the investor gain a significant amount of money (Baker & Riddick, 2013).

Differences & similarities between Options & Futures

The options and futures contracts seem quite similar to each other. However, there are many differences which make them different from each other. The following are the key differences between options and futures:

·         The options give the right to investors to purchase the shares on a specific price at a specific date; however, it is not obligatory for the investor.

·         The futures contract gives the right to the investor to purchase the shares on a specific price on at any future date. However, it is obligatory for the investor to purchase.

·         The options contain a lesser risk than future

·         Future contracts are riskier because of the obligation to purchase and sell (Sercu, 2009).

Conclusion on Use of option & Futures in Investment Program

If all the above discussion are summarized than it can be said that the options and future both are financial products which are utilized by the investors for the creation of money and for minimizing the risk. Options provide the right to the investors to purchase or sell shares on a specific price at any time until the contract is valid. However, it is not an obligation for the investor.  On the hand, futures contracts are the obligation for the buyer to sell or purchase the shares on specific future time on the agreed price. The options and futures contracts seem quite similar to each other. However, there are many differences which make them different from each other.

References of Use of option & Futures in Investment Program

Baker, H. K., & Riddick, L. A. (Eds.). (2013). International Finance: A Survey (illustrated ed.). OUP USA.

Hull. (2010). Options, Futures, and Other Derivatives. Pearson Education, India.

Madura, J. (2008). International Financial Management. Cengage Learning.

Sercu, P. (2009). International Finance: Theory into Practice. Princeton University Press.