What is the difference between Futures and Options?
- 02 Mar 2024
- By: BlinkX Research Team
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Options and futures derivatives have been recognized to distinguish between investors seeking to benefit from the price change in commodities or similar investments and those simply hedging their bets. The main difference between options and futures is that the contract holder must exercise underlying assets, such as commodities or stocks, at a future date. On the other hand, an option allows the contract holder to decide whether or not he will execute the contract in the derivative market.
This difference impacts how options and futures are traded and priced and how traders can profit from them.
Let's focus on the future first. Think that the share price of XYZ company, which is at 100 Indian rupees right now, would rise. You're trying to make some money by taking advantage of this opportunity. You'll buy 1000 futures contracts for XYZ company at a strike price of Rs 100. Whenever the cost of XYZ company rises to Rs 150, you can exercise your right and sell your futures at Rs 100 each and gain Rs 50,000.
Remember that options give you a right, not an obligation, to buy or sell. If you had purchased the same amount of options at ABC company, you could have exercised your right to sell options at Rs. 150 and made a profit of 50,000, just like a futures contract. The option of not exercising the right will save you from a loss of INR 50,000 if the stock price falls below Rs. 50.
This should make it easier to see the difference between futures and options.
Understanding Options Trading
An options contract is a derivative contract to purchase and sell an underlying asset at a price fixed on or before its expiration date. The value of these contracts is determined based on security. The buyer may purchase or sell the underlying asset depending on the option type. The two options are as follows:
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Table of Content
- Understanding Options Trading
- Understanding Futures Trading
- Options vs Futures - Which is better?
- Factors making a difference between Futures and Options
- Difference between Futures and Options based on Liquidity
- Difference between Futures and Options based on Value
- Difference between Futures and Options based on Capital
Understanding Futures Trading
Futures are nothing more than futures contracts. A futures contract is when a contract holder buys underlying assets on a predetermined date despite the asset's market price. As a result, once the contract is purchased, they decide how much to pay. Any physical commodity, such as oil, corn, or other financial assets, can be an underlying asset.
The standardised amount shall be used in futures contracts for each main asset. You will not be required to place a total value on the contract when purchasing futures contracts. By contrast, you hold a significantly small proportion of the funds needed to finance your investment, referred to as first margin payments. Moreover, there will be variations in the contract value.
In addition, your broker may require you to deposit money if you experience a significant loss.
Most commodity traders tend to liquidate their positions before expiration. You may obtain sufficient funds to cover the margin loan when you sell a futures contract, and that may give you some profit.
Options vs Futures - Which is better?
After understanding the difference between futures and options, both derivatives have gained traction due to their advantages—lower risk, leverage, and liquidity. Let’s see which is better for you.
Futures | Options |
|---|---|
| Gained popularity due to lower risk, leverage, and high liquidity. | Became popular among investors for similar advantages. |
| A derivative instrument tied to an underlying asset's value. | Classified as derivatives dependent on underlying asset value. |
| Applicable across various assets like stocks, indices, currencies, and commodities (e.g., gold, silver, wheat, etc.). | Derivatives are available for multiple financial instruments and commodities. |
| Utilized for both hedging against volatility and speculative purposes. | Used for hedging risks caused by market volatility and for speculating on price movements. |
| Beneficial for producers, traders, and investors facing potential losses due to market fluctuations. | Facilitates potential gains for speculators accurately predicting price movements. |
Factors making a difference between Futures and Options
Factors that make a significant difference between futures and options are listed below;
The table below clearly indicates the difference between futures and options in detail.
| Options | Futures | |
|---|---|---|
| 1. Risk | They are subjected to limited risk | Higher risks are involved. |
| 2. Advance Payment | The buyer has to pay an advance premium payment. The advance gives the option buyer a chance not to buy any asset if the future date is unattractive. | No advance payment is involved in the future. The buyer just needs to pay the price of the asset. |
| 3. Execution | Options can be executed anytime before the expiration date. | Futures contracts are executed on a specified agreed date. |
| 4. Profit or loss | It can either give you a profit or a loss. The outcome is not specified. | Futures almost always bear profits for buyers. |
| 5. Obligation | The buyers are not obligated to meet a specific date to buy the contract. | The buyer is obligated to buy the contract by a predetermined date to buy a contract. |
Difference between Futures and Options based on Liquidity
The most basic type of commodities derivative is a futures contract. They are the closest thing you can get without really trading a commodity to trading the real one.
Comparatively speaking, these contracts are more liquid than option contracts. Futures contracts are, therefore, more suited for day trading.
Difference between Futures and Options based on Value
Because options move in combination with futures contracts, futures contracts move quicker than option contracts.
For in-the-money options, this may be 50%, while for severely out-of-the-money options, it might only be 10%. You don't have to be concerned about the option value gradually declining over time.
Difference between Futures and Options based on Capital
The capital value of futures options is regarded as high risk. Put another way, alternatives are becoming less and less valuable every day. Time decay is the term for this, and it becomes worse as options go closer to expiry.
Consequently, it is possible to characterize futures and options as exchange-traded derivative contracts that are transacted on stock exchanges like the National Stock Exchange or the Bombay Stock Exchange.
Making the most effective use of these instruments is crucial for trading futures vs options differences. Their coverage includes financial instruments such as equities, bonds, currencies, commodities, and more.
Conclusion
As discussed above, these derivative contracts are customised according to counterparties' requirements. Options contracts may decrease losses as opposed to futures contracts, guaranteeing an obligation that will be fulfilled at a particular time. To improve the investor's ability to make better informed and well-reasoned choices, an analysis of key differences between futures and options and how they are bought and sold plays a vital role. It was all you could have known about options and futures.
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