Futures and Options vs Equity: Which is Best for Your Strategy?

Investing money for returns is an age-old practice. However, with the advancement of financial markets, investors today have a range of assets to choose from. Amongst the most popular investment assets are – equity, futures, and options. While all three offer returns, they differ in their risk-reward profile. As an investor, it becomes critical to understand these differences before putting your hard-earned money to work. 

This article covers the key contrasts between equity, futures, and options to help you make an informed choice.

The basics of equity

Equity or stocks refers to ownership interest held by shareholders in a company. When you purchase company shares, you become a part owner and are entitled to a share of its future profits as dividend or price appreciation. Key things to know about equity are:

1. Reward is linked to company performance – If the company does well, stock prices and dividends tend to go up
2. Risk is proportionate to business uncertainties – Declining sales, losses, etc., can lead to falling stock valuations
3. High growth potential in the long term – Historically, equity has delivered inflation-beating returns over long periods
4. Ownership rights via voting power – Shareholders have a say in key decisions of the company

However, equities tend to be a vehicle of choice for investors who seek high capital appreciation over long durations and are willing to stomach interim volatility.

What are futures?

A futures contract allows an investor to buy or sell a standardised quantity of an asset at a preset price and on a predetermined future date. For instance, one could agree today to buy 100 units of gold after 3 months at Rs. 5000 per unit. Futures are a common way to speculate on price movements in commodities, currencies, indices, etc. Here are some salient aspects:

1. Price agreed today, delivery in future – Helps mitigate risk from adverse price moves 
2. Standardised contract specifications – Removes ambiguity and eases trading
3. Used for speculation and hedging – Popular tools for short-term bets and risk management  
4. Notional ownership, no physical delivery – Except for some commodities, cash settlement is the norm
5. Margins needed to control risk – Small price variations require mark-to-market margins

In a nutshell, futures suit intraday traders and speculators who wish to benefit from short-term directional bets. Their standardised nature promotes liquidity and flexibility.

Understanding options 

Options give buyers the right but not the obligation to buy or sell the underlying asset at the agreed strike price on or before the expiry date. Call options confer the right to buy, while put options give the right to sell. The following factors set options apart:

1. Limited downside, unlimited upside loss restricted to option premium paid
2. Hedging instrument to transfer risk used to insure portfolios from extreme moves
3. Versatile strategies possibly range bound, directional, or volatility play viable  
4. Better leverage than margins: Small premiums can control larger asset exposure
5. Complex pricing and Greek risks require a nuanced understanding  

Investing in options can be a great way to leverage your investment and limit your potential losses. However, having experience and knowledge about how they work is important so you can use them effectively. Option options allow you to control a large amount of money with a smaller investment, but you must understand how to use them wisely.

Equity futures vs equity options  

Both equity futures and options allow you to invest in a stock without buying it. Although they may seem similar, there are some important differences between the two that you should know about:

1. Equity futures have compulsory settlement, while options can expire worthless
2. Futures witness daily mark-to-market settlements leading to margin risks
3. Options trading involves a limited, defined risk through payment of premium 
4. Futures provide higher leverage, benefitting short-term traders
5. Options lend well to long-term directional and volatility strategies

Based on one’s risk appetite, investment horizon, and objective, equity futures or equity options can offer a route to benefit from stock movements.

Making the optimal choice 

Stocks are a good way to invest for the long term and grow your money steadily. Futures and options, on the other hand, are more like short-term bets that can help you make quick profits, but they come with more risk. The following pointers can help you decide:  

1. Investment goal and time horizon – Wealth creation via equities is a marathon, while futures and options offer shortcuts for meeting short-term objectives
2. Risk tolerance and loss-bearing ability – Equities require a higher appetite for interim volatility versus defined losses in options
3. Strategies to be deployed – Options provide more versatility through combinations, while futures excel for directional bets.  
4. Portfolio balance and concentration risk – Equities promote diversification, while options and futures warrant position limits

It is a good idea to make sure that your investment goals, willingness to take risks, and strategy match the type of investments you choose. A combination of investing in stocks to grow your capital and using options to protect against potential losses can be a smart approach.

Conclusion

While equity, futures, and options may seem intimidating initially, a systematic understanding goes a long way. Clarifying investment objectives, risk tolerance, strategy selection, and appropriate asset allocation is vital. Equity suits long-term wealth creation needs. Futures and options meet short-term trading aspirations. Maintaining portfolio balance while aligning choices to individual profiles is key. Evaluate merits and demerits to make an informed pick.

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