Futures and options are tools that traders use in the stock market to make immediate gains from stocks. These instruments provide an opportunity for enormous profits as financial contracts between the buyer and seller of an asset. However, there are some significant differences between futures and options.
Futures contracts are those contracts which are focused on trading an underlying asset at a pre-determined price at a future date. In such contracts, buyer and seller both should complete the transaction on that date. On the other hand, options contracts are standardized contracts which allow traders to trade an underlying asset at predetermined price before a specific date. Call and put options are 2 types of options which are available in the market.
While this is the basic difference between the two, read on to find out the major differences between them.
What is the difference between Futures and Options contracts?
Obligation
A futures contract refers to a contract between two parties to buy or sell an asset at a certain price in the future. In this case, the buyer is required to mandatorily purchase the asset on the specified future date. On the other hand, an options contract grants the buyer the right to purchase the asset at a predetermined price. However, the buyer is under no obligation to do so. Nonetheless, if the buyer decides to purchase the asset, the seller is obligated to sell it.
Risk
Even if the security moves against the holder of futures contract, he/she is obligated to buy on a future date. Therefore, even if the asset’s market price falls below the price specified in the contract, the buyer will still have to pay the price which he/she agreed upon.
On the other hand, a buyer of an options contract has an advantage. If the asset’s value falls below the agreed-upon price, the buyer can choose not to buy. The buyer’s loss is thus minimized. Simply out, a futures contract holder can see unlimited profit or loss. However, an options contract can bring unlimited profit while lowering the losses.
Payment in advance
While entering into a futures contract, there are zero upfront costs. However, the buyer is obligated to pay the agreed-upon price for the asset at some point. In an options contract, the buyer is required to pay a premium. The payment of this premium gives the option buyer the right of not purchasing the asset at a later date. If the options contract holder decided not to buy the asset, the premium paid is the only amount he/she can lose.
Contract execution:
A futures contract is completed on the date specified in the contract. Therefore, on the agreed-upon date, buyer has to purchase an underlying asset. Meanwhile, the buyer of an options contract is allowed to exercise contract at any time before the expiration date. Therefore, a buyer has a freedom of purchasing the asset whenever the situation seems favourable to him/her.
