What is an Outright Futures Position
An outright futures position is a long or short trade that is not hedged from market risk. Both the potential gain and the potential risk are greater for outright positions instead of positions covered or hedged in some way.
Outright futures are also called naked futures because they leave the investor highly exposed. To reduce risk, the investor may choose to purchase a protective, offsetting option, an offsetting position in the futures' underlying security, or an opposite position in a related market.
BREAKING DOWN Outright Futures Position
An outright futures position is inherently risky because there is no protection against an adverse move. Most traders do not consider trading liquid futures contracts to be excessively risky, especially because in most cases it is easy to cover or to sell the position back to the market. However, a declining market for an investor holding a long position in a futures contract still has the potential to deliver significant losses. In this case, holding a put option against the long futures position could, for a small price, cap losses to a manageable amount.
Traders selling futures short without hedges face even greater risk since the upside potential for most futures markets is theoretically unlimited. In this case, owning a call on the underlying futures contract would limit that risk.
Another alternative to an outright futures position that can sometimes carry less risk is to take a position in a vertical spread trade. This caps both profit potential and risk for loss, and would be a good choice for a trader that only expects a limited move in the underlying security or commodity.
Synthetic Futures Contracts
An example of a financial instrument a trader might choose instead of an outright futures position is a synthetic futures contract, which is a combination of options positions that mimic the performance of a regular futures contract. The difference is that the upfront costs are likely lower because the trader does not actually buy the value of the futures contract until the options expire or he or she exercises them. However, it does lock in the price the trader will pay at the end of the trade.
To create a synthetic long futures contract, the trader buys a call option and sells a put option at the same time. Both options must have the same strike price and expiration date. The trader will typically pay a net option premium because not all the premium paid for the long position is offset by the sale of the short position.
For a synthetic short futures contract, the trader buys a put and sells a call, again with the same strike price and expiration date.