Once you have gotten to grips with the basics of building an expat portfolio and have a bit of experience and comfort in trading various asset classes such as ETFs, Equities, etc, you might want to broaden your investment horizons and look at other financial products that are available.

The most common next step for retail investors is typically in trading equity options.

Equity options fall under the umbrella of what we call "Financial Derivatives" or "Derivatives Contracts" or often just "Derivatives" for short.

As their name would imply, derivatives are financial products that derive their value from an underlying asset.

The most common types of financial derivatives are what we call "Futures Options" and "Futures Contracts" both of which operate in a very similar, but very distinct way.

Futures Options

The use of Futures Options allows investors to make outsized bets on the future value of an asset with limited downside.

In this article we will cover the Future Option to BUY an asset at a future date for a fixed price.

These types of Futures Options contracts are know as "Call Options".

The option to SELL an asset at a future date for a fixed price, are known as "Put Options" and are covered in their own article.

Let's say we have an individual equity – lets call it 'ABC' – which is currently trading at $10 a share.

We think that by this time next year, 'ABC' will be trading at $20 a share.

We have $1,000 to invest.

The classic approach here to capture this upside would be to buy the stock and hold it for a year.

Buy 100 x ABC @ $10 = -$1,000

Sell 100 x ABC @ $20 = $2,000

The main downside here is the fact that all of your capital is tied up in the investment and the potential gain is limited by the volume of shares you are able to buy outright today for cash.

However, utilizing equity Future Options we can avoid both of those downsides by either spending a much reduced initial outlay of capital, achieving a multiple of our successful outcome, or a mixture of both of these.

Futures options are a contract that gives the owner the option, but not obligation, to buy or sell an asset at a fixed future date for a fixed price.

It's important to note at this point that Equities Options Contracts are sold in lots of 100 shares, which means any contract must be a multiple of 100 shares.

The key items here to take into account are:

- Expiration Date – When they contract is valid until? - Strike Price – What price you have the option to buy at? - Premium – How much you will pay for this option contract?

With that in mind, we can also use futures options pricing as an indicator of where the market thinks a stock price will be at a point in the future.

In the above example, let's imagine that the options market looks like the following:

Equity Futures Option Contract – ABC (Currently trading at $10) - Strike date: 1 year from today - Premium: $1 - Number of Contracts: 1

If we were to buy this contract we would pay $100 in premium ($1 premium * 100 shares in 1 contract) and get the option to buy 100 shares for $1,000 1 year from now.

By looking at the premium, we can see that the market predicts that 1 year from now a share of ABC will be trading at $11.

Price today: $10 Option premium: $1 Implied future price: $11

So let's run this thought our scenario in which the future price of ABC rises to $20.

Premium Paid: -$100 Buy 100 shares of ABC @ $10 = -$1,000 Sell 100 shares of ABC @ $20 = $2,000 For a realized profit of $900

In this situation we realized a slightly lower profit, but we benefited in two other ways:

Firstly, our maximum loss from this deal was limited to $100. We kept $900 of our $1,000 capital free for the entire duration of the year.

Let's now imagine that ABC has a terrible year and rather than hitting $20 it instead falls to $5.

Buy buying the shares directly: Buy 100 shares @ $10 = -$1,000 Sell 100 shares @ $5 = $500 For a realized loss of -$500.

However, if we had bought the futures options: Premium Paid: -$100 Decline the option to buy 100 shares of ABC @ $10 = $1,000 For a realized loss of -$100 only (the premium paid).

Comparison table:

| | ABC @ $20 | ABC @ $5 | |--|-----------|----------| | Buy Equity Directly | $1,000 | -$500 | | Buy 1 Futures Option | $900 | -$100 | | Buy 10 Futures Options | $9,000 | -$1,000 |

So, there we go.

Equities Futures Options can be used as a financial tool to limit potential downside on an investment – at the expense of a share of the potential upside, or to multiply the potential upside – at the expense of increased risk of loss, both without having to use leverage.