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1 January 1981 Financial Analysts Journal Volume 37, Issue 1

A Comparison of Options and Futures in the Management of Portfolio Risk

  1. Eugene Moriarty
  2. Susan Phillips
  3. Paula Tosini

Do options serve portfolio management needs distinct from those served by futures? The key, of course, is the profit and loss potential provided by each kind of instrument. Gains and losses on open futures positions are limited only by the price of the underlying asset. Gains on an option are virtually unlimited for the purchaser (subject to the movement of the underlying stock) but limited to the option premium for the writer. Losses, on the other hand, are virtually unlimited for the writer but limited to the premium for the purchaser.

Hedging—i.e., taking a position in a derivative market that represents a substitute for a transaction to be made at a later date—can be accomplished with either futures or options. But a single futures position can neutralize exposure in the underlying asset. Accomplishing the same hedge with options requires either simultaneous put and call transactions in three separate markets (assuming put-call-futures parity), or so-called “delta” hedging (which entails continuous adjustments, hence significant transactions costs).

On the other hand, options possess characteristics that cannot be effectively simulated by positions in the futures market. In particular, the option purchaser can insure himself against a decline in the value of his underlying assets, while the option writer can generate income over and above the asset’s normal coupon or dividend yield. So long as there remains sufficient demand for the specialized functions each serves, it is unlikely that options will dominate futures, or vice versa, even if both are traded on the same underlying assets.

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