Financial Management

What are the Differences between Future and Options?

Futures and options are both types of financial derivatives that allow traders to speculate on the future price of an underlying asset. However, there are some key differences between the two.

Futures

A futures contract is a legally binding agreement to buy or sell an underlying asset at a predetermined price on a specified future date. The buyer of a futures contract is obligated to buy the underlying asset, and the seller of the contract is obligated to sell it. Futures contracts are traded on exchanges, and they are standardized contracts, meaning that the terms of the contract are the same for all traders.

For example, if you buy a futures contract for $100 of a company’s stock on July 31st, you’re selling the stock on that date for $100. If the stock price goes up, you’re effectively “calling” the company and forcing them to buy your stock at the $100 price by the end of the contract.

Options

An option is a financial instrument that gives you the right to buy or sell an asset at a given price within a specified period of time (the “expiration” date). If the underlying asset moves up or down, the value of your option will change, too.

For example, if the price of a stock is $100 at the time you buy an option, your option will be worth $110 (the $100 price + $10 premium). If the price of the stock goes up to $110, your option will now be worth $120.

Future and Options have recently been very popular in financial markets and among investors.

There are some differences between both, elaborated below:

Differences between future and options

  1. The futures involves obligation while the options involve right. In the future, both parties must fulfil the obligation, but in the case of options, only one party must perform the contract. The option holder has the right to exercise or not exercise his option. When he decides to exercise his option, the option writer must fulfil his obligation.
  2. In the futures, there is no premium payable to buy the contract. But in the case of options, the option holder has to pay a premium to buy the option.
  3. The profit or loss of the parties depends upon the specified price and the actual price on the settlement day under futures. Hence, both parties are exposed to unlimited profit or loss. However, in the case of options, the loss of the option holder is limited to the premium paid, but his gains are not limited. Similarly, the option writer’s profit is limited to the premium received, but he is exposed to unlimited risk.
  4. Normally, the maturity period of futures is longer than that of the options.

Which is Right for You?

The choice of whether to trade futures or options depends on your investment goals and risk tolerance. Futures are riskier than options because you are obligated to fulfil the contract if it expires in the money. Options are less risky because you only have to pay the premium if you choose to exercise the contract. However, options also have a limited profit potential, whereas futures have an unlimited profit potential.

If you are a beginner investor, it is generally recommended to start with options trading before moving on to futures trading. This is because options are less risky and easier to understand. However, it is important to do your research and understand the risks involved in trading both futures and options before you invest.

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