Hedging a Futures Option Position

The benefits/drawbacks of trading equity options vs Futures options is a frequent question I receive as a trading mentor. While there are several points to that question, I want to talk about one of the advantages of Futures options trading over equity options.

Provided you select the correct market, futures and futures options trade nearly 24 hours a day. One way to take advantage of that in an option position is to hedge that position with contingent orders to go long or short futures contracts at extreme points of your risk range. Everyone who trades options has experienced the “gap” opening at the beginning of an equity trading session. The price can move beyond your established risk parameters and you cannot easily protect your position. Since futures trade nearly 24 hours a day the gap risk is very small. Further, having contingent futures orders in at the extreme edges of your risk range can protect you and can get filled even in overnight moves at the time the price breeches your range. Once the future contract(s) order is filled, it can help hedge any losses until you have time to repair or exit your option trade. A butterfly position is a good example. You can place orders to go long a future at the upper end of your risk graph and an order to go short a future at the lower end of your risk graph. You cannot however go on total “auto pilot” as the future can whipsaw against you. You need to repair your option trade in a timely manner then exit the future position. Hedging with futures contracts is another useful tool for you to have in your trading arsenal. As always, having a plan and sticking to it will reward your trading business.

Mark Fenton

mark@sheridanmentoring.com