Week 11: Introduction to Options and Futures

First off, what are options and futures?

Options and futures are financial derivatives—a fancy way of saying that their value comes from something else, like a stock, commodity, or market index. Think of them as contracts that investors use to either protect their investments (hedging) or try to make a profit from changes in prices (speculation).

Let’s break it all down in a way that’s clear and simple.

Options give you both flexibility and choice

An option is like a reservation: it gives you the right, but not the obligation, to buy or sell an asset at a certain price before a certain date.

There are two main types:

• A Call option gives you the right to buy something at a set price.

• A Put option gives you the right to sell something at a set price.

Let’s look at a quick example: Imagine you think a stock (let’s call it Stock X) is going to go up. You buy a call option with a strike price of $50, and the stock rises to $70. You can still buy it at $50 and immediately sell it at $70. That’s a $20 per share profit (minus the cost of the option, of course).

But what if the stock never rises above $50? No worries—you’re not obligated to buy it. You just let the option expire, and the only thing you lose is the premium (the price you paid for the option).

Here are some important terms to understand:

• Strike price: The agreed-upon price you can buy or sell the asset for.

• Premium: The cost of the option—it’s what you pay up front.

• Expiration date: The last day the option can be used.

Options are powerful because:

• They offer flexibility.

• They limit your downside risk (you can only lose the premium).

• They can be used in tons of strategies—from simple income generation (like selling covered calls) to complex trades involving market volatility.

Futures are what they sound like… commitment and planning ahead

A futures contract is a binding agreement to buy or sell something at a specific price at a future date.

Unlike options, futures are a two-way street: both parties are obligated to complete the transaction when the contract expires.

Let’s say you’re a corn farmer worried about prices falling before harvest. You sign a futures contract to sell your corn in three months at $4 per bushel. If prices fall to $3, you’re safe—you still get your $4.

But if prices rise to $5? You still only get $4, because that’s the price you locked in. So there’s a tradeoff: security vs. opportunity.

Key characteristics of futures:

• Standardized: Every contract is pre-set in terms of quantity, quality, and delivery.

• Leverage: You only need to put down a portion of the contract’s total value, known as margin, which lets you control a large position with relatively little capital.

• Obligation: You’re locked in—you can’t just walk away like with options.

Make sure you know what these mean!

• Margin: A good-faith deposit that acts like collateral.

• Settlement: The way the contract wraps up—either by physical delivery (rare for most investors) or more commonly, with a cash payment.

Now you might be wondering, why even use options and futures?

1. Hedging Risk Let’s say you own stock in a company. What if the market turns? You could buy a put option as insurance. Or if you’re running a business and worried about the cost of raw materials, futures contracts help you lock in prices.

Real-world hedging examples:

• Airlines buy fuel futures to guard against rising oil prices.

• Farmers lock in grain prices months before harvest.

• Exporters hedge against currency fluctuations.

2. Speculating for Profit This is where people try to guess which way prices are headed:

• Think oil is going up? Buy a futures contract.

• Think a stock is about to soar? Buy a call option.

• Think it’s going to drop? Try a put option.

But remember: these are high-risk, high-reward plays.

3. Income Generation (for Options) Some investors sell options to earn steady income. For example:

• Selling a covered call means you collect a premium—and if the stock doesn’t move much, you keep the money without selling your shares.

Now I’m going to help you get started!

Step 1: Learn the Lingo That’s what you’re doing now! You’re building your foundation by understanding the terms, the mechanics, and the reasons people use these tools.

Step 2: Choose a Broker You need a brokerage that offers options and futures trading.

Best for beginner options traders: Charles Schwab

• Easy-to-use platforms with educational content

• Thinkorswim by Schwab is a great analysis tool

• But…Slightly higher fees compared to some competitors

Best for beginner futures traders: Charles Schwab

• Access to global markets

• Advanced automation tools

• But…platform might feel complex for first-timers

Step 3: Create a Strategy

• Are you trying to protect what you own (hedging)?

• Or make a profit from price changes (speculation)?

• Know your goals, how much you’re willing to risk, and your exit plan.

Step 4: Practice First Most brokers offer paper trading, where you can test your strategies using fake money. This is the safest way to learn.

Step 5: Risk Management is Crucial

• Use stop-loss orders to limit potential losses.

• Never put all your money into one position.

• Stay diversified and never invest money you can’t afford to lose.

Risks you should be aware of:

Leverage Risk: Because you're using borrowed buying power, your losses can be bigger than your original investment.

Market Risk: Prices can move against you quickly—and sometimes irrationally.

Liquidity Risk: If there aren’t enough buyers or sellers, you may be stuck with a contract you don’t want.

Time Decay (for options): Every day that passes, your option may lose value if the stock isn’t moving how you expected.

Assignment Risk (for options sellers): If you sell an option, you might be forced to fulfill the contract—whether it’s convenient for you or not.

Volatility Exposure: Big price swings can either help or seriously hurt your position.

Options and futures aren’t just Wall Street tools—they’re ways regular investors and businesses can protect what they have or capitalize on what they think will happen.

The bottom line is that with such great financial power comes great financial responsibility!

Keep learning. Start small. Practice before you jump in. And always know the risks before you make a move.

If you’re thoughtful and educated, options and futures can open up a whole new world of investment opportunities.