Futures vs Options
Options and futures are derivative contracts that allow the trader to trade the underlying asset and obtain benefits from changes in prices of the value of the underlying asset. Both options and futures contracts are used for hedging, where these contracts can be exercised to reduce the risk associated with the price movements of an asset. Options and futures contracts are both equally important to any trader, and their use will depend on the purpose for which they are required. The following article clearly explains the two and provides a clear distinction between them.
What is an Options Contract?
An options contract is a contract that is sold by the option writer to the option holder. The contract provides the trader with the right and not the obligation to buy or sell an underlying asset for a set price during a specified period of time.
There are two types of options; a call option that gives the option to buy at a specific price and a put option, which gives the option to sell at a specific price. A buyer of an option would want the price of the asset to go up so that the trader will be able to exercise his option and buy at a lower price currently.
For example, an asset X is valued at $10, and the option buyer buys an options to purchase the asset at $8. If the price of the asset increases to $12, the trader can exercise his option and purchase the asset at a lower price of $8. A seller of an option, on the other hand, would want the price to up so that he may exercise the option and sell at a higher price.
What is a Futures Contract?
Futures contracts are standardized contracts that list out a specific asset to be exchanged on a specific date or time at a specified price. The exercising of a futures contract is an obligation and not a right. The standardized nature of futures contracts allows them to be exchange traded on a financial exchange called the ‘futures exchange market’.
Futures contracts operate through clearing houses that guarantee the transaction will take place, and therefore ensures that the buyer of the contract will not default. Settlement of a futures contract occurs daily, where the changes in price are settled on a daily basis until the contract expires (called marked-to-market).
Futures contracts are usually used for speculation purposes, where a speculator bets on the movement of the price of the asset, and make profit depending on the accuracy of their judgment.
What is the difference between Futures and Options Contracts?
The major difference between these two contracts is that the options contract gives the trader an option as to whether he wants to use it, whereas the futures contract is an obligation that does not give the trader a choice.
A futures contract does not entail an additional cost, whereas an options contract requires the payment of an extra cost called the premium. If the options contract is not exercised, the only loss will be the cost of the premium.
Summary:
Futures vs Options
- Options and futures both are derivative contracts that allow the trader to trade the underlying asset and obtain benefits from changes in prices of the value of the underlying asset
- An Options contract is a contract that is sold by the option writer to the option holder. The contract provides the trader with the right and not the obligation to buy or sell an underlying asset for a set price during a specified period of time
- Futures contracts are standardized contracts that list out a specific asset to be exchanged on a specific date or time at a specified price. The exercising of a futures contract is an obligation and not a right
- The major difference between these two contracts is that the options contract gives the trader an option as to whether he wants to use it, whereas the futures contract is an obligation that does not give the trader a choice.