The choice between using futures versus employing options for a trend-following program is worth reviewing after the recent market events. Would trend-followers who used options have done better than those who expressed their directional bets with futures? The key to this answer is whether the trend-follower had a view on volatility.

Most trend-following is done through futures and not options, so there must be clear reasons for this preference. The simple reason for this focus on futures is that there are less moving parts.

Most trend managers have not been able to include in their models all of the choices represented in options. For futures, the choice is simple. Find the direction. You don’t have to forecast the size of the move or when it exactly will occur. All you have to do is get the sign right.

If options are used to express the trend view, the forecasting decision is much more complicated. You have to get the sign right just as with the futures trade. Additionally, you have to forecast the size of the move and express this view through picking a strike. You have to get the timing of the price move right because there is time decay (theta), and you need to have a view on volatility (vega).

A general rule of thumb is that most trend-followers will have winners only about a third of the time, another third are scratch trades, and the final third are losers. The size of the winners will offset the other 2/3rds of the trades that either are flat or have a loss. There is a lot of room for error, yet still an opportunity for profit if the winners are associated with big moves.

There is less room for forecasting error with options given the choices that have to be made. This is especially true when futures positions are structured to act like an option through combine the trend decision with a stop. The stop-loss rule creates an option pay-off without the payment of a premium. These created synthetic options do not have time decay. They will still be affected by volatility but the creator does not have to pay for the volatility through a premium.

The February volatility spike would have been costly for any wrong bet because the reversal of option positions would be more expensive given the embedded cost of volatility in the option price. Consequently options as a means of expressing trends hold only be undertaken if the trader has deeper view on the strength of trends and the market environment.