Main Difference – Futures vs Options
Futures and options market have become largely important in the world of finance and investment market. Options and futures are widely used to prevent risks such as exchange rate risk and commodity risk, and they help to cover their fixed costs on items that can be changed in future. Further price for options and futures contracts are highly unstable. So investors need to take decisions about options and futures by accepting certain risks, and they need to consider margin accounts before agreeing with the customers on selling or purchasing options or futures. The main difference between futures and options is that futures always trade on exchanges whereas options trade both on and off exchanges.
This article covers,
1. What are Futures?
2. What are Options?
3. What is the difference between Futures and Options?
What are Futures
A financial contract that declares the sale of financial instruments or physical commodities for future transfer is called futures. In Future contracts, it is agreed to trade a promised asset at a future date at a predestined price. Both buyer and seller have the liability to transact on that date according to the agreement. Futures are standardized contracts which investors can buy or sell trades on an exchange. This concept began in the US to buy and sell commodities such as cotton, corn, and wheat. Nowadays Futures cover numerous items such as currency, stocks, interest rates and commodities such as crude oil, grain, and livestock.
What are Options
An option is a right to buy or sell a stock or other security for a specified price on or before a specified date. Types of investments that can be optioned include stocks, bonds, real estate, businesses, currency, and commodities. Options can be used to hold the right to purchase or sell some financial instruments or physical commodities. It is not necessarily an agreement to sell or buy; it only provides the right to trade. There are two types of options: call options and put options. There are also four participants in the options market.
- Buyers of calls
- Sellers of calls
- Buyers of puts
- Sellers of puts
Call Option
This provides the holder the right (but not the obligation) to purchase an underlying asset at a specified price (the strike price), for a certain period of time. If the stock fails to meet the strike price before the expiration date, the option expires and becomes worthless. Selling an option is also denoted as ”writing” an option.
Put Option
This gives the holder the right to sell an underlying asset at a specified price. The seller of the put option is obligated to buy the stock at the specified price (strike price). Put options can be exercised at any time before the option expires.
Similarities Between Futures and Options
- Both Futures and options are standardized contracts
- Both have daily settlements
- Both need to conduct margin accounts.
Difference Between Futures and Options
Definition
Futures: Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset at a predestined future date and price.
Options: Options are contracts through which a seller gives a buyer the right to buy or sell a specified number of shares at a predestined price within a set time period.
Obligation
Futures: The buyer and seller are both obligated to complete the transaction on the specified date at the price set in the contract.
Options: The buyer is not obliged to complete the transaction. If the buyer of the option chooses, the seller is obliged to transact.
Transaction Date
Futures: The date is specified in the contract.
Options: Options can be transacted any time before the expiry date specified in the contract.
Exchange
Futures: Futures always trade on exchanges.
Options: Options trade both on and off exchanges.
Futures vs. Options Conclusion
In a derivative market, Investors can either deal with futures or options contracts. Futures and Options are both derivative instruments. Futures and options have many advantages over other types of investments. For example, the commission charges for futures trading are relatively small compared to other types of investments; it is possible to open short as well as long positions. Position can be reversed easily, and it has high liquidity. The risk of option contracts are also lower and have higher potential returns. Due to all these reasons, futures and options are good ways to invest in any financial market.
Image Courtesy: Pixbay
