The Divvys Guide to Futures

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The Divvys Guide to Futures

• By Amanda Alexander

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Lets Start with an Example
A company buys a futures contract which says on
30th September it will buy a tonne of coffee at
1,500 a tonne. This means that whatever the
market price is on 30th September it will still
only pay 1,500. As the price starts to go up
the futures contract has a positive value as the
contract price is lower than the current market
price, but if the price goes down the contract
has a negative value.
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A Definition of Futures

• A futures contract is a legally binding
  agreement, usually made on a futures exchange, to
  buy or sell a commodity, financial instrument
  (e.g. a government bond) or stock sometime in the
  future.

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Options

• An option gives the buyer the right but not the
  obligation to buy or sell something at a fixed
  price in the future.
• There are two types of options
• A CALL Option
• A PUT Option

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Option Types

• A CALL option gives the buyer of the option the
  right to buy the underlying financial instrument
• A PUT option gives the buyer of the option the
  right to sell whatever it is.

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An Example of Options Trading

• If your share is worth 150p you can buy an option
  to sell it at 150p in three, six or nine months'
  time.
• You can sell your shares for 150p at any time
  during the selected period for 150p, regardless
  of whether the current price then is 100p or 10p.
  
• All it will have cost you is the cost of buying
  the option. But if the shares rise you will have
  lost what you paid for the option.

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Some Bits N Bobs

• If you are buying options you have a limited risk
  - you can only lose what you paid for your
  options. It is the people selling (or writing, in
  investment speak) the options who can lose far
  more than their initial investment
• So why do traders write options? Basically
  because the odds are in their favour.
• The futures and options market is one of the few
  where you can really make a profit when prices
  are dropping.
• For novices the best insurance policy is to buy
  options rather than sell them.
• You need to be disciplined and not inclined to
  panic. You need to be able to afford to lose
  money
• Both futures and options fall into a class of
  financial instrument known as derivatives. They
  are known as derivatives because they derive
  their value from the price behaviour of some
  other 'underlying' asset which, in the case of
  equity derivatives, is individual shares or stock
  market indices

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Sources

• http//www.liffe.com/liffeinvestor/ LIFFE - The
  London International Financial Futures and
  Options Exchange - is committed to bringing this
  world of trading and investing opportunities to
  the private investor, both through education and
  through a continuous process of product
  enhancement and development. An excellent
  website with a great step by step free learning
  centre all about futures, options and derivatives
• http//www.financialmail.co.uk/undated/si4987.html
  An article about futures and options
• http//www.thisismoney.com/share_school/index.shtm
  l Share school - a 12 part all about/how to
  guide to investing. Also free.