If the thought of investing in real estate, index funds, mutual funds -- or even day trading individual stocks -- bores you, you may be ready to take your investments to the next level. Many of the world's most successful investors have achieved this status by seeking higher-risk, higher-reward ventures such as options and futures. However, these investments can be risky, and shouldn't be purchased without first doing a substantial amount of research. Read on or talk to companies like SJB Futures, LLC to learn more about how to purchase options and futures, as well as learning how these types of investments may be able to fit into your portfolio.
Simply speaking, purchasing an option does not give you a tangible commodity, like a share of stock -- instead, it gives you the option (but not the obligation) to purchase or sell a stock, piece of real estate, or commodity at a later point. For example, if a childhood friend is starting his own business, you may wish to purchase an option to buy shares in this business. If this business grows and decides to go public, you should be able to purchase shares at a dramatically reduced cost as compared to the IPO price. On the other hand, if the business folds, you are out only the cost of the option -- rather than losing all the shares you would have otherwise purchased.
Options can be risky in and of themselves, but can also be a good way to hedge your bets -- reducing your overall risk. Although you do always run the risk of losing the funds invested to purchase the option (either when the option expires, or when you decide not to exercise it), you are also given the freedom to decide whether or not to purchase a commodity, and avoid any troubling decisions about when to sell a declining stock.
Futures are another speculative investment that can involve high risk, but also carry the potential for huge gains. By purchasing futures, you are setting the price for the purchase of a future investment. If you'd like to be truly speculative, you can combine options with futures and purchase the option to buy a future commodity at a specific price.
If you've seen the movie Trading Places with Eddie Murphy and Dan Aykroyd, this illustrates the concept well. In this movie, Murphy and Aykroyd's characters attempted to defraud two wealthy investors by giving them a fake crop report, which caused them to think that the future price of orange juice would be high. These investors purchased orange juice futures, with the plan to sell the futures once the report was released and the price skyrocketed. Aykroyd and Murphy's characters sold the futures at these inflated prices, knowing that the true crop report would cause the price to plummet. When the true report was released, the cost of the futures did plummet -- causing the wealthy investors to lose billions. Meanwhile, Aykroyd and Murphy's characters repurchased the futures they had sold at their inflated price, turning a hefty profit.
In the real world of trading, it is unlikely that such a scenario would have happened at that magnitude, as the stock market has safeguards in place to limit trading during huge price fluctuations. (It's also likely that trading on non-public knowledge could have led to federal charges for Murphy, Aykroyd, and the two investors). However, the principle behind this scene is otherwise solid.
Stops and limit orders
Stops and limit orders are ways to control your losses if one of the above investments goes sour. When purchasing an option or a futures contract, you can determine a "floor" price -- the price at which the investment becomes too speculative for your risk tolerance and you want to get out. By putting in a stop order, you can ensure that all shares are automatically sold when that price is reached. However, once the price is reached, the stop order is converted into a market order, which means that it will be filled in the order it was received. If the price is quickly trending downward when your stop order is triggered, you may end up selling below your stop order price.
A limit order is similar to a stop order, but gives you a firmer reign on the selling price. Instead of being sold at the market price once the stop order price is reached, a limit order is sold for the exact price specified.