What are 'ETF Futures and Options'

ETF futures and options are derivative products built on existing exchange-traded funds. Futures represent an agreement to buy or sell shares of an underlying ETF at an agreed-upon price on or before a specified date in the future. Options, on the other hand, give the holder the right, but not the obligation, to trade the underlying ETF shares at an agreed-upon price on or before a specified date in the future.

Derivatives in the ETF market operate the same as an individual equity option or futures contract. These products are typically used to take a speculative bet on the economy, index or specific sector with less capital outlay.  

BREAKING DOWN 'ETF Futures and Options'

ETF futures and options have grown in popularity with the increased adoption of standard exchange-traded funds. These unique products provide the efficiency of a traditional ETF with the flexibility of options trading. By doing so, investors can gain exposure to the performance of an index or sector without committing large amounts of capital.

In addition, options are a great tool for hedging against a drawdown in a specific sector or asset classes. Having these mechanisms can enhance a portfolio's return, as investors profit from the movements of an ETF with an added layer of leverage. Getting started with ETF options is logistically the same as traditional options trading. There are standard put and call options traded in blocks of 100 shares in the underlying asset. 

ETF futures operate much the same as a normal futures contract. These contracts never take possession of the asset, but keep the capital moving from one basket of futures to another. This means investors don't have direct exposure to the underlying assets and must deal in cash terms. Most ETF futures track the commodity and currency markets as is the case for normal futures contracts. Commodities invite speculative trades on the future price movements of raw materials used to produce various products. 

Risks with ETF Futures and Options

The biggest disadvantage of ETF futures is the contango effect. This occurs when the future price of a commodity exceeds the expected future spot price. In other words, the future spot price is below the current price and investors are willing to pay more for the commodity in the future than its true value. Furthermore, derivatives like options and futures are dangerous for inexperienced investors. Both products are time-sensitive investments subject to systematic drawdowns, counterparty risk, and price risk.

RELATED TERMS
  1. ETF of ETFs

    An ETF of ETFs is an exchange-traded fund (ETF) that tracks other ...
  2. Stock Exchange-Traded Fund (ETF)

    A stock exchange-traded fund (ETF) is a security that tracks ...
  3. Commodity ETF

    A commodity ETF is an exchange-traded fund that invests in physical ...
  4. International ETF

    An international exchange traded fund (ETF) is any ETF that invests ...
  5. Double Gold ETF

    A double gold exchange-traded fund (ETF) is designed to respond ...
  6. Listed Option

    A listed option is a derivative security traded on a registered ...
Related Articles
  1. Trading

    Examples Of Exchange-Traded Derivatives

    We look at some of the most common exchange-traded derivatives.
  2. Financial Advisor

    How to Invest Your Excess Cash in Commodities ETFs

    Discover how commodity-based ETF investments can help diversify your investment portfolio.
  3. Tech

    How To Pick The Best ETF

    Of the hundreds of exchange-traded funds on the market, some are bound to fail. Learn how to pick the best of the bunch.
  4. Investing

    Leveraged ETFs: 3 Benefits Over Options (SSO, SPY)

    Find out how options function like leveraged instruments and learn about the ways in which leveraged ETFs might be more suitable for some investors.
  5. Investing

    The Advantages of ETFs Compared to Index Funds

    With the ongoing ETF boom, ETFs gain more variety and increased competition in the market leads to further investors' advantages compared to index funds.
  6. Investing

    How are ETFs Taxed? What You Must Know

    Understanding how taxes on ETFs and their efficiency is an important part of the appeal offered to investors as a portfolio-enhancing tool. Learn more.
  7. Investing

    Guide To ETF Providers

    The exact number of ETFs on the market at any one time ebbs and flows, these twelve ETF providers offer hundreds of popular ETFs.
  8. Investing

    Advantages and Disadvantages of ETFs

    You've probably heard that ETFs are better than mutual funds, but you need to consider all aspects before investing. Learn them here.
RELATED FAQS
  1. Are ETFs considered derivatives?

    Learn why most exchange-traded funds (ETFs) are not considered derivative securities and the special circumstances when this ... Read Answer >>
  2. Do ETFs generate capital gains for shareholders?

    Learn how exchange-traded funds (ETFs) can generate taxable capital gains for shareholders due to occasional and substantial ... Read Answer >>
Trading Center