Difference Between Futures and Options
- 5m0•
- 08 Feb 2023
Understanding what are futures and options, particularly the points of difference between the two, will help you to use these trading tools in the best possible way. However, if you’re looking for difference between Covered and Naked options contracts, click here.
Options vs Futures - Which is Better?
The table below provides a thorough comparison of options and futures.
Particulars
Meaning
Futures
Futures contracts are agreements to transact in an underlying asset at a specified price at a later date. Both the buyer and the seller are required to finish the deal on that day. Investors can buy and sell futures on an exchange. Futures are typical contracts.
Options
Options contracts are standardised agreements that let investors trade an underlying asset at a specified price before a particular date (the options' expiration date). There are two different types of options: call and put. While the buyer of a put option has the right to sell the security, the buyer of a call option has the right (but not the obligation) to acquire the underlying asset at a fixed price prior to the option's expiration date.
Particulars
Gain or Loss
Futures
It might experience countless gains and losses.
Options
Although it lessens the likelihood of suffering a possible loss, it might still bring you endless profit and loss.
Particulars
Risk
Futures
They are exposed to greater risks.
Options
The limited risk applies to them.
Particulars
Obligation
Futures
The buyer is required to purchase the item on the specified future date.
Options
In this, neither the buyer nor the contract's execution are required.
Particulars
Payment in Advance
Futures
There is no entry fee when entering a futures contract. However, the buyer is eventually obligated to pay the agreed-upon price for the item.
Options
In an options contract, the buyer is expected to pay a premium. The premium payment gives the option buyer the choice to decide not to acquire the asset at a later time if it starts to lose its appeal. It should be noted that the premium paid is the amount the options contract holder is intended to lose if he decides not to purchase the asset.
Particulars
Execution of a Contract
Futures
A futures contract is put into effect on the predetermined date. The buyer purchases the underlying asset on this specific day.
Options
The buyer of an option may exercise it at any time before the expiration date. As a result, a person is willing to purchase the asset anytime the circumstances look favourable.
| Particulars | Futures | Options |
|---|---|---|
| Meaning | Futures contracts are agreements to transact in an underlying asset at a specified price at a later date. Both the buyer and the seller are required to finish the deal on that day. Investors can buy and sell futures on an exchange. Futures are typical contracts. | Options contracts are standardised agreements that let investors trade an underlying asset at a specified price before a particular date (the options' expiration date). There are two different types of options: call and put. While the buyer of a put option has the right to sell the security, the buyer of a call option has the right (but not the obligation) to acquire the underlying asset at a fixed price prior to the option's expiration date. |
| Gain or Loss | It might experience countless gains and losses. | Although it lessens the likelihood of suffering a possible loss, it might still bring you endless profit and loss. |
| Risk | They are exposed to greater risks. | The limited risk applies to them. |
| Obligation | The buyer is required to purchase the item on the specified future date. | In this, neither the buyer nor the contract's execution are required. |
| Payment in Advance | There is no entry fee when entering a futures contract. However, the buyer is eventually obligated to pay the agreed-upon price for the item. | In an options contract, the buyer is expected to pay a premium. The premium payment gives the option buyer the choice to decide not to acquire the asset at a later time if it starts to lose its appeal. It should be noted that the premium paid is the amount the options contract holder is intended to lose if he decides not to purchase the asset. |
| Execution of a Contract | A futures contract is put into effect on the predetermined date. The buyer purchases the underlying asset on this specific day. | The buyer of an option may exercise it at any time before the expiration date. As a result, a person is willing to purchase the asset anytime the circumstances look favourable. |
How Futures And Options Contracts Differ
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Obligation:
A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Here, the buyer is obliged to buy the asset on the specified future date. You can read up the basics of futures contract here.
An options contract gives the buyer the right to buy the asset at a fixed price. However, there is no obligation on the part of the buyer to go through with the purchase. Nevertheless, should the buyer choose to buy the asset, the seller is obliged to sell it. If you want to know more about an options contract, you can read about what is Options trading,
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Risk:
The futures contract holder is bound to buy on the future date even if the security moves against them. Suppose the market value of the asset falls below the price specified in the contract. The buyer will still have to buy it at the price agreed upon earlier and incur losses.
The buyer in an options contract has an advantage here. If the asset value falls below the agreed-upon price, the buyer can opt out of buying it. This limits the loss incurred by the buyer.
In other words, a futures contract could bring unlimited profit or loss. Meanwhile, an options contract can bring unlimited profit, but it reduces the potential loss.
Did you know that though derivatives market is used for hedging, currency derivative market takes the centre stage for hedging? You can read about it here.
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Advance payment:
There is no upfront cost when entering into a futures contract. But the buyer is bound to pay the agreed-upon price for the asset eventually.
The buyer in an options contract has to pay a premium. The payment of this premium grants the options buyer the privilege to not buy the asset on a future date if it becomes less attractive. Should the options contract holder choose not to buy the asset, the premium paid is the amount he stands to lose.
In both cases, you may have to pay certain commissions.
Click here to know the brokerage offered by Kotak Securities’ Dynamic brokerage plan.
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Contract execution:
A futures contract is executed on the date agreed upon in the contract. On this date, the buyer purchases the underlying asset.
Meanwhile, the buyer in an options contract can execute the contract anytime before the date of expiry. So, you are free to buy the asset whenever you feel the conditions are right.
Similarities between futures and options
The following are the parallels between futures and options that maintain the fundamentals of these contracts:
- Both are stock exchange-traded derivative contracts.
- Key information on the trade, price, quantity, and date is specified while creating the contract.
- The settlement of both futures and options occurs every day.
- Both contracts are standardised and call for a margin account.
- These contracts' underlying assets include financial instruments including currencies, commodities, bonds, equities, etc.
Futures Options - Points To Remember
1. Contract details:
At the time of drawing up a futures or options contract, four key details will be mentioned:
- The asset that is up for trade
- The quantity of the asset that is available for buying or selling
- The price at which it will be traded
- The date on which (futures contract) or by which (options contract) it must be traded
- The futures contract will also mention the method of settlement.
2. Trade venue:
The trade in futures takes place on the stock exchange. The options trade takes place both on and off the exchanges.
3. Types of assets covered:
Futures and options contracts can cover stocks, bonds, commodities, and even currencies.
4. Requirements:
You would need a margin account to trade in futures and options.
(Learn about the different types of options contracts )
Conclusion
Both are derivatives contracts, as was said before, and they may be tailored to the needs of the counterparties. Contrary to futures contracts, options contracts can limit losses; nevertheless, futures contracts provide the assurance of a transaction being completed on a specific date.
The goal is to safeguard the contract's initiator's interests while speculating on price movement. As a result, depending on their comfort level with taking risks and faith in their intuition, the buyer and seller may agree to a contract. The execution of a futures contract is likely because an exchange is involved, whereas options lack this option. However, by paying a premium, one can lock in a contract, and depending on how prices move towards the end of the duration, the contract may be executed or allowed to expire worthless.
FAQs on Difference Between Futures and Options
In the stock market, futures and options (F&O) are derivative instruments. Because they derive their value from an underlying asset, such shares or commodities, they are known as derivatives. In a derivative contract, two parties agree to purchase or sell the underlying asset at a predetermined price and on a certain date.
Futures are appropriate for people looking for direct exposure and higher risk because they give more obligation and leverage. Options are beneficial for strategic hedging and fluctuating market circumstances since they offer flexibility and low risk.
No, unlike call options, which give the opportunity to buy at a predefined price within a specified time period but are not contractually obligated to do so, futures are contracts that require trading at a specific price and date.
Options give the right but not the duty to purchase or sell an asset at a specified price within a certain term, whereas forward contracts are customisable agreements between two parties to buy or sell an asset at a given price on a future date.
Due to margin restrictions, futures frequently have lower upfront prices, but options provide little risk for the cost of the premium. The cost comparison is based on the requirements for risk management and trading strategy.
Compared to options, which provide less risk in exchange for the premium paid, futures might contain more risk because of their obligation and possibility for significant losses. The evaluation of risk is based on each trader's objectives and methods.
Options provide the following benefits: Flexibility, low risk for the premium paid. Costlier premiums and maybe more complicated techniques are drawbacks.
Due to leverage and possible losses, futures and options trading can be dangerous, but with the right knowledge, risk management, and methods, they can be utilised securely to meet certain financial objectives.
Options often have larger leverage since they demand less money up front than futures contracts do, which increases both potential gains and losses.
The profits from futures and options depend on market conditions and risk tolerance of investors. Futures may offer higher returns. However, they are more risky. Investors can use options according to their trading strategy. They can use call options in bullish markets and put options in bearish markets.
