Derivatives Trading for the Masses

By now, millions of Americans have several years' experience trading their online accounts. As such, it seems inevitable that growing numbers of these folks will want to graduate from plain old stocks to the high-octane risks and rewards offered by derivatives trading.

At least that seems to be the thinking behind two new online brokerages I looked at this week, optionsXpress and MyFuturesOnline.com. Both brokerages seem aimed at bringing derivatives trading to the masses.

Derivative products like options and futures give traders control over an asset -- stocks in the case of equity options; metals, currencies and a long list of other commodities in the case of futures -- for a small fraction of that asset's actual cost. That massive leverage is what makes derivatives both enticing and potentially dangerous. Trading options and futures, it's possible to lose more money than you invested. If you're a newcomer to either, check out the Chicago Board Options Exchange and Chicago Mercantile Exchange's educational Web sites on options and futures.

Truth is, most of us are neophytes when it comes to derivatives. Just a few years ago, brokerages specializing in options and futures served a rarified, knowledgeable clientele, often providing expert-level advice in exchange for the kind of commissions full-service brokerages charge.

optionsXpress and MyFuturesOnline.com have brought those commissions down to Internet-broker levels. But beyond that, if you check out their Web sites, you'll see that through the features they offer and through subtleties like their sites' designs, both have managed to put a friendly face on derivatives trading -- all the better to attract newcomers, of course. Here's a closer look at the two.

Options for Everyone

Like the name says, optionsXpress.com is for equity options traders. You can trade stocks, funds and bonds, too, because these can figure into options strategies. But options trading is definitely the main event.

When you trade options, you can do so online or by phone. Often it's helpful to have someone help walk you through a complicated position, although some online brokerages discourage phone orders except when their systems are down.

What I liked about optionsXpress is that customers get real-time options chains, which are listings of all the contracts available for sale at every strike price and expiration .

Independent quote vendors like WindowOnWallStreet.com or DTN.IQ.com charge $80 or so per month for real-time options chains. So this is a nice perk, and a useful one.

An options chain gives you a hint of what other traders are doing. Is trading heavy at certain strike price ranges and expiration dates, for example? These can be clues as to where savvy investors believe a stock will move to, and when. Also, a real-time options chain lets you track hundreds of potential positions without having to enter a new symbol time after time.

Now what I really liked about optionsXpress is that customers with sufficient experience can use a variety of options strategies within a tax-deferred account such as an IRA. Options trading within an IRA is a sticky issue with many online brokers, with most limiting you to simple strategies such as buying long options or selling covered calls . Some strategies are clearly verboten under IRS rules and could result in your IRA being disqualified (this CBOE white paper offers a full explanation).

But many strategies can help protect your returns or boost them. And they should rightfully be part of the arsenal of tools available in a tax-deferred account, particularly because that's where many of us keep the bulk of our investments.

On to commissions. optionsXpress charges $1.50 per contract with a $14.95 minimum. That's roughly in line with what online brokers like Ameritrade, Datek and Scottrade charge. However, optionsXpress charges $19.95 for equity trades, significantly more than what those three charge. If you trade only one or two contracts at a time, then InteractiveBrokers.com has a better deal at $1.95 per contract. But there you don't get the real-time options chains or the same flexibility to trade options within a tax-deferred account.

All in all, optionsXpress has some nice features and is worth taking a look.

Futures Without Fear

Outside agricultural circles, people tend to be even less familiar with futures trading than they are with options trading. So a name like MyFuturesOnline.com can make this arena seem a lot less intimidating. If the name sounds familiar, think Mydiscountbroker.com. The two brokerages operate as separate companies. But their Web sites are heavily linked and co-branded, which may reassure you if you're thinking of trading futures on unfamiliar commodities such as coffee, wheat, gasoline or metals.

Indeed, part of the allure of futures trading is that so many different markets exist, while the basic strategies for trading them are essentially the same. Trading takes place around the world and around the clock. And thanks to the leverage a futures contract gives you, the slightest price change in the underlying commodity can bring about a quick profit -- or loss. So there's always action somewhere. The wheat futures market might be in a slump, but platinum might be on a tear.

Still, if I had to bet, I'd say most people outside the business will never feel comfortable trading futures in pork bellies, orange juice or precious metals. But many in the industry expect they'll take naturally to a new product in the offing: single stock futures.

Single stock futures will be contracts written on select, widely held stocks. Among their advantages: Although yet to be finalized by regulators, margin requirements will likely be lower than the 50% limits typical of equities trading. Also, unlike stocks, you can sell a futures contract short without worrying about the uptick rule. (Designed to curb volatility, the uptick rule requires that a stock trade at a price higher than the transaction immediately preceding it before it can be shorted.) Another advantage: Investors will be able to trade single stock futures within their regular securities accounts, meaning they won't have to open a separate futures account. Trading in single stock futures is expected to begin in late December.

MyFuturesOnline.com CEO Jim Curley told me he expects single stock futures will account for a hefty chunk of his brokerage's business in the years ahead. Commissions are $6 per online trade -- more for phone orders that come with "support and guidance (futures brokers commonly offer such mentoring programs). Those rates roughly equal fees at Alaron.com, another dedicated derivatives broker courting online traders. But MyFuturesOnline.com also bundles in some fairly sophisticated charting software -- technical analysis is important to many futures traders -- and an order-entry interface that will look familiar to online stock traders.

Hey, if single stock futures catch on and if brokerages like MyFuturesOnline.com lure in new converts, it could spark a daytrading revival.

>To order reprints of this article, click here: Reprints