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Chapter 2.9: Difference between Futures and Options

Futures and options are tools used by investors when trading in the stock market. As financial contracts between the buyer and the seller of an asset, they offer the potential to earn huge profits. However, there are some key differences between futures and options. Click here if you want to know how to buy and sell Futures Contracts.

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.

HOW FUTURES AND OPTIONS CONTRACTS DIFFER


Futures Options By Kotak Securities®

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,


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.


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.


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.

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 )

What next?

By now, you have studied all the important parts of the derivatives market. You know what are derivatives contracts, the different types of derivatives contracts, futures and options, call and put contracts, and how to trade these. Congrats! It is time to wrap up this section and move on to the next—mutual funds.

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  • Helps compute taxes
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