Regulatory Differences Between Stock and Future Options

Many of the differences between stock and futures options involve not only methods of trading but also how the industries are regulated. Virtually all listed options on stocks are traded electronically, meaning execution is instantaneous or nearly instantaneous in most cases. However, although some futures exchanges use electronic trading, the prevailing method is open outcry, or a vocalized bidding system that has been in place for many decades.

Under this method, verbal bidding is used to trade options on futures as well as on futures contracts themselves.
Buyer and seller negotiate prices by calling them out. A trader making an offer gets a completed trade if a trader on the other side and within the trading pit accepts verbally. Part of the reason for continuing to use this antiquated method involves differences in regulatory structure of the exchanges.

All trading in stocks and equity options is regulated by the SEC as well as the self-regulatory securities firm, the National Association of Securities Dealers (NASD). Options trading is further regulated by the Options Clearing Corporation (OCC), which facilitates the orderly market through the central exchange called the Chicago Board Options Exchange (CBOE). In addition, securities accounts and margin requirements are governed by the Federal Reserve Board (FRB) and its Regulation T, specifying how much a customer has to keep on deposit in a margin and cash account.

All trading in futures and futures options is regulated by the CFTC and the self-regulatory firm, the National Futures Association (NFA). Rules concerning how customer funds are managed and accounted for make the business of operating a commodity brokerage firm much different that that for a stock brokerage firm. The rules for maintaining cash and futures positions is far different than the requirements for the stock market and for options on stocks. The complexity of the futures market is not limited to the nature of the trading unit and settlement rules; it also includes the rules for setting up trading accounts, the costs involved, and cash levels required.

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The differences in regulation and in regulatory bodies also distinguishes levels of risk and methods of trading between stock-based and futures-based options.

For most traders focused on a portfolio of stocks and the use of options to protect positions or to enhance short-term profits, expanding into options on futures may be too exotic. The futures industry demands great expertise and often the acceptance of a different range of risks and trading costs than most stock market-based traders can absorb. Many traders diversify into commodities by focusing on commodities-based ETFs and indices as a result; this is often the most practical alternative to directly buying or selling futures options.

For advanced traders, diversification and hedging is accomplished by combining stock-based options with futures options. For example, you may own shares in an energy company and enhance or offset those shares by trading in shares of an energy-industry ETF or in an ETF focusing on the energy sector. The same approach may be employed for numerous other market sectors or for financial instruments such as interest rates or foreign currencies. However, these methods and strategies are for the advanced trader. As with any exploration of a new method of speculating or trading, thorough knowledge of the rules for trading and of the risks involved is always a wise first step.

Expanding on the idea of seeking new markets, you may also want to explore the possibilities of trading options on the many available market indices. This industry has exploded in popularity along with the growing volume of traditional equity options. Index-based options trading is one way to diversify while expanding potential profits and portfolio risks, but through the advantageous leveraging attributes of options.
By Michael C. Thomsett
Michael Thomsett is a British-born American author who has written over 75 books covering investing, business and real estate topics.

Copyrighted 2016. Content published with author's permission.

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