What You Are Actually Buying
A share, a futures contract, an option and a perpetual are four different legal objects. Which one you are holding fixes four things that no amount of skill will change: the smallest position you may take, whether it expires, the most it can take from you, and who is obliged to pay you when you are right. On one view, long the S&P 500 with the index at 5,000, the smallest position the four of them permit runs from $500 to $250,000, and none of that gap is a judgement about markets.
Prerequisites: Lesson 12, which ranked the instruments, and lesson 10, for financing, which is the charge one of these four collects every few hours.
Your platform will show you four ways to be long the same index, arranged as though they were four buttons for one decision. They are four different contracts. Each has a different counterparty, a different way of ending, and a different worst case, and the differences are not details of execution — they are the risks.
A share
A share is a fractional claim on a company. It does not expire, and nothing has to happen on any particular date. It divides down to one share, and at most brokers to a fraction of one, so the position can always be made small enough to fit the account. What you can lose is what you paid, because ownership carries no further obligation. And nobody owes you anything: you hold an asset and realise it by selling to whoever will buy, which is exactly the friction problem lesson 12 measured.
A futures contract
A futures contract is a standardised obligation to exchange a fixed quantity at a fixed date, and it is guaranteed by a clearing house that steps between the two sides. Two things follow from “standardised” and “fixed date”. The exchange sets the unit, so the contract cannot be cut in half; and because it ends, holding a view past expiry means closing one contract and opening the next. For index futures that happens about four times a year, and each of those is a round trip whose cost belongs in the friction arithmetic you built in lesson 12.
Expiry has a second consequence that shows up on the screen rather than in the account. The long futures chart you look at is not one contract; it is several stitched together, with the prices on either side of each join shifted so the series does not jump. That adjustment is what makes the chart readable, and it also means the historical prices printed on it are not prices anything ever traded at. A level drawn across a join refers to a number that never existed. Lesson 63 takes up what this does to a backtest; the rule here is narrower and immediate, which is to know which parts of your own chart are constructed before you draw on them.
The obligation runs both ways, which is why what you can lose is not bounded by what you deposited. In exchange you get the strongest counterparty of the four: the clearing house, not the person who took the other side.
An option
An option is a right on one side and an obligation on the other, and that asymmetry is the entire object. If you bought it, the most you can lose is the premium you paid, which is genuinely bounded — but it expires on a stated date, so it can reach zero while you were right about the direction and wrong only about when. Time is a term in the contract, not a matter of patience.
If you sold it, every clause reverses. You received the premium, which is the most you can make, and you took on the obligation, which is what you can lose. The two sides of one contract are not two versions of the same trade.
A perpetual
A perpetual swap is built so that it never expires, and that creates a problem the other three do not have: with no settlement date forcing it back to the spot price, nothing would stop it drifting away. So the design replaces the deadline with a payment. Longs and shorts exchange a funding amount directly with each other, typically every eight hours, in whichever direction pulls the contract back towards spot.
That is worth stating plainly, because it is lesson 10’s financing charge wearing a different name: a perpetual has no roll to pay for and a continuous charge instead, and unlike the other three the sign of that charge changes — some days you pay it and some days you are paid it. Its counterparty is the exchange itself, and that is the weakest of the four: where a liquidated position cannot be closed at a price that covers its own loss, the major venues meet the shortfall out of the profitable positions on the other side.
The smallest position each one permits
Take one view — long the S&P 500, with the index at 5,000 — and ask each object how small a position it will let you take.
An S&P 500 ETF trades at about a tenth of the index, so one share is roughly $500, and one share is the minimum. The Micro E-mini future is worth $5 an index point, so one contract controls 5,000 × $5 = $25,000. The full-size E-mini is worth $50 a point, so one contract controls $250,000. Same index, same direction, same afternoon: the smallest position runs from $500 to $250,000, a factor of five hundred, and none of that is a judgement about markets.
| Object | Smallest position | Expires | Most it can take | Who owes you |
|---|---|---|---|---|
| Share or ETF | One share, about $500 | No | What you paid | Nobody |
| Futures contract | One contract, $25,000 of index | Yes, quarterly | More than you deposited | The clearing house |
| Option, bought | One contract, 100 shares | Yes, on a stated date | The premium | The clearing house |
| Perpetual swap | A fraction of one unit | No, but it charges funding | Your whole margin | The exchange |
The option row is the one that repays a second look. One contract covers a hundred ETF shares, so it carries about $50,000 of exposure, while a one-month at-the-money contract on an underlying moving 16 per cent a year costs roughly $920 to buy — the standard approximation for an at-the-money option is 0.4 × price × volatility × √time, which is 0.4 × $500 × 0.16 × √(1÷12) = $9.24 a share. The exposure is more than fifty times the outlay, and the outlay is also the entire loss. No other row has those two properties at once, and that combination is why options are simultaneously the most and the least dangerous object in the table, depending only on which side of the contract you took.
Read the second column as the decision it actually is. With shares you size the position to the account. With futures you must size the account to the position, because the position has a floor the exchange chose and you cannot go under it. That is not a difficulty to be traded around, and it is not a sign of an inadequate method. It is a property of the object, settled before you have an opinion.
What this does not settle
That one of them is better. Every column is a constraint rather than a verdict, and the same row reads as a warning or as a convenience depending on the size of the account and the length of the hold. The point of putting them in one table is that the four constraints are knowable in advance, not that three of the rows are mistakes.
Nor is it a complete list. Contracts for difference, spread bets, warrants and structured notes are all objects a retail account can hold somewhere in the world, and which of them you may hold at all depends on where you live. These four are here because between them they cover the distinct combinations of the four columns; a fifth object is worth learning by asking it the same four questions.
It also says nothing about tax, which differs by object and by jurisdiction more sharply than any other line in this course and is lesson 78. And the clearing house being the strongest counterparty of the four is not a claim that it cannot fail. It is a claim about ranking, and the ranking is the useful part.
The $920 also rests on one assumption, and it is the one that moves most. That premium came from an underlying moving 16 per cent a year; put the same contract on something moving 30 per cent and it costs about $1,730, and the exposure-to-outlay multiple falls from fifty-four to twenty-nine. “More than fifty times” is a property of a quiet market, not of options.
And the second column answers a question about exposure, which readers will take as a question about risk. They are not the same. One Micro E-mini controls $25,000 of index and a ten-point stop on it risks $50, while a hundred ETF shares are $50,000 of exposure and a one per cent stop on them risks $500. The object with the larger floor is the one risking less. What the table settles is the smallest exposure each contract will let you hold, and lesson 20 is where exposure and risk finally get separated properly.
Four objects, four questions, and every answer available before you risk anything. Almost nobody asks the second one until the date arrives.
Problems
- Name the object you are holding. Take your current position, or the last one you closed, and write which of the four it was. Then fill in that row’s four columns from your broker’s own contract documentation rather than from memory. The fourth is the one no platform displays, and answering it means opening the contract document itself.
- The smallest honest position. For whatever finished top of your ranking in lesson 12, find the smallest position each object available to you permits, in money rather than in units. Compare that floor with what your account can carry at the stop your method actually uses. If the floor is higher, the object has already made the decision, and no amount of conviction moves it.
- Find the date. For any expiring object you hold or would consider, write down the exact date it ends and what happens on that date if you do nothing at all. Then write what you had assumed happens. Two of the four rows have a date and they do not behave the same way when it arrives, and the gap between your two sentences is the whole value of the exercise.
Sources. CME Group, contract specifications for the E-mini and Micro E-mini S&P 500 futures, which is where the point value and the fixed unit come from and is the primary document rather than anyone’s summary of it. Options Clearing Corporation, Characteristics and Risks of Standardized Options, the disclosure every United States options account must be given before it trades, and the clearest statement anywhere of the asymmetry between buying and writing. John Hull, Options, Futures, and Other Derivatives, on what clearing actually does and why it changes who your counterparty is.
You now know what kind of thing you would be holding. The next lesson takes the one number your platform puts in front of you before you buy it, and shows that it measures something other than what you are about to risk.
Every Trade Starts Negative
Financing, which one of these four objects collects every eight hours.
Read Lesson →What Should You Actually Trade
Choosing the instrument, which this lesson turns into choosing the object.
Read Lesson →Margin and Leverage
The collateral two of these four objects require, and what it does not measure.
Read Lesson →When Your Broker Acts Without You
What happens on the date, and at the level, that the object fixed in advance.
Read Lesson →Educational only. Trading involves substantial risk of loss. Not financial advice. Past performance does not guarantee future results.
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