CMFAS M9A Understanding Derivatives question: Compared with buying a long call

CMFAS M9AUnderstanding Derivatives

An investor takes a long position in a stock index futures contract to speculate on a rise in the index. Compared with buying a long call on the same index, the long futures position:

A has its downside risk limited to the initial margin deposited with the broker
B exposes the investor to substantial downside risk that is not capped at a premium
C can be used only for hedging, because speculators are barred from index futures
D offers the same limited downside as the call, but at a lower upfront cost

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Answer: B. exposes the investor to substantial downside risk that is not capped at a premium

A long futures position has very high downside risk — as the index falls, losses mount without limit. A long call's loss, by contrast, is capped at the premium paid. Speculating with futures can bring large gains but equally large losses.

Common mistake

Only the option (long call) limits the loss to the premium; the futures holder must settle the full adverse move, so leverage cuts both ways.

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