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Trading Stocks, Futures and Options

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How Stocks, Futures and Options Relate To Each Other

Stocks, Futures and OptionsTrading Stocks, Futures and Options in conjunction with each other is a way to hedge against market risk and take full advantage of trading opportunities, as they arise.  This trading and investing strategy is more suitable for experienced investors who understand how Stocks, Futures and Options relate to each other as investment vehicles.

Traders and investors buy or sell short stocks because they are the purest way to play a company’s performance and anticipated events, either company specific or economic.  Trading financial instruments such as options in conjunction with or in lieu of buying or selling short stocks can be a very sound and profitable stock market trading strategy.

A good way to use options in conjunction with holding a long stock position is to hedge
against an unexpected drop in the price of the stock and guarantee a profit by buying put options for the stock with a strike price at or slightly below the stock’s current trading level.  This strategy allows a trader or investor to lock in profits in a stock and keep holding the stock in case it continues to increase in price.  If an unexpected price drop happens in the stock due to unforeseen events, the holder of the put options has the right to sell the stock at the put options’ strike price, thus locking in their profit at the level of the option’s strike price.

Options can also be used to protect a trader’s or investor’s downside risk associated
with holding a stock long or short, by buying options to buy or sell a stock in lieu of buying or selling short a stock.  If the stock does not move as anticipated after an option trade is initiated, the loss associated with buying an option is limited to the premium (fee) that they paid to buy the option.  On the other hand, if the stock makes a significant unanticipated price move upwards or downwards, the loss associated with going long or short a stock can be substantial.

Options also allow traders and investors to control more shares than they can control
by buying or selling short a stock directly.  Since options represent lots of 100 shares and cost just a fraction of what many stocks trade for, traders and investors can take a larger position in a stock in anticipation of a move higher or lower by buying options, and can book much larger profits, if the trade works out as expected than they would be able to holding a stock long or short.  Paying less to get into an option trade also frees up investment capital for other uses.

Trading futures based on commodity contracts that represent a variety of commodities
from agricultural products to precious metals is an excellent way to hedge against volatility in the stock market and inflation, and to diversify investments into an asset class that is not directly related to stocks.  Stocks can selloff due to a drop in corporate earnings.  At the same time, commodities can stay flat or even rise, since they are affected by supply and demand forces, not corporate earnings.  Also, commodities often rise in conjunction with inflation, which makes holding commodities a hedge against inflation.

Where To Learn More About Trading Stocks, Futures and Options

Those who wish to trade stocks, futures and options contracts are encouraged to learn as much as possible about buying and selling stocks, futures and options. Options and futures can be a very useful trading tool to protect a trader or investor’s stock positions and to hedge against unexpected market moving events.  To learn more about trading stocks, options, and futures contracts, see the following articles:  Stock Market Basics, Option Trading Basics, and Buying and Selling Futures.

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