Difference between Futures and Options

Difference between Futures and Options

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Jaya
Jaya Sharma
Assistant Manager - Content
Updated on Aug 29, 2023 18:48 IST

The key difference between futures and options lies in their contractual nature and risk-reward profiles. Futures contracts obligate both parties to fulfill the terms of the contract, exposing them to potentially unlimited gains or losses. In contrast, options provide the buyer with the choice, but not the obligation, to execute the contract, while the seller is obligated.

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In this article, we will be learning the difference between futures and options in detail. Futures and Options are the financial instruments that are available for trading. 

Table of Contents

Difference between Futures and Options

In this article, we will be discussing the differences between futures and options.

Aspect Futures Options
Contract Nature Obligatory for both parties to fulfill Buyer has the choice, seller has the obligation
Risk and Reward Potentially unlimited gains and losses Limited risk for the buyer, potential for high gains
Trade Flexibility Limited flexibility to customize terms Highly customizable contracts
Trading Platform Traded on organized exchanges Traded on both organized exchanges and OTC (Over-the-Counter) markets
Pricing Price determined by market forces Price determined by market forces and “strike price”
Settlement Cash or physical delivery of the asset Cash settlement or physical delivery (rare)
Initial Investment Requires margin deposit Requires premium payment
Time Sensitivity Fixed expiration date Expiration date and various expiration periods
Example Agricultural commodities, stock indices Equity options, currency options, index options

What are Futures?

Futures refer to the derivative financial contracts that obligate parties to either buy or sell an asset at a predetermined date in future and price. It is essential for the buyer and seller to sell the underlying asset at a set price even if the current market price has changed after the expiration date. 

Types of Futures Contract

There are several types of futures contracts including the following:

  • Equity index futures: When you do not want to trade stocks, you can instead buy or sell index futures. Equity index futures speculate on the movement of broad-based indices having lower risk than stock futures. These are useful for hedging and arbitrage. 
  • Currency futures: This allows you to bet on currencies such as euros, yen, pounds and dollars. You can buy USDINR futures in the expectation that the rupee will strengthen. Then you can sell USDINR futures. 
  • Equity stock futures: These have been present in an organized format for the past 20 years in India. These are the financial contracts that bound parties to sell and buy assets at a pre-determined price in future at a set date. These come with a maximum of three-month expiry period with the last Thursday of that month as being the settlement date.
  • Commodity futures: It is an agreement of buying or selling a commodity at a predetermined amount at a specific date or price in future. It can be used for hedging or protecting an investment position or for betting the directional move of an underlying asset.  
  • Interest rate futures: These are the types of futures that pay interest. These are the underlying contract is an agreement between a buyer and seller for a future delivery date of an interest-bearing asset. It allows buyers and sellers to lock in the price of interest-bearing assets for a date set in future. 

What are Options?

Options refer to the type of derivative with their value depending on the value of underlying statement. Such an underlying instrument may be stock, commodity, currency or any other type of security. The investor gets the right to buy or sell the asset at a predetermined price by a particular date. It gives the right to buy yet it is not an obligation on investors. 

Types of Options

There are two types of options that either give the right to buy or the right to sell. 

  1. Put option: It allows the owner with the ‘right to sell’. Put option holder has the right to sell as stock at a stock price within the expiration period. An investor can place the put option when the investor expects the market price to fall. This happens during the bear market phase. Put holder has the right to sell at the strike price. The strike price is higher than the market price at that time which allows the investor to make a profit.
  2. Call option: It gives the owner of this contract with the right to buy the stock at an agreed-upon price. This is also known as the strike price. The investor has the right to buy the option at a time before or on expiration date. When the stock market trend is of bull market, the investor can exercise the option and buy the stock at strike price which is below the market price. The investor can make profit at this point.
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About the Author
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Jaya Sharma
Assistant Manager - Content

Jaya is a writer with an experience of over 5 years in content creation and marketing. Her writing style is versatile since she likes to write as per the requirement of the domain. She has worked on Technology, Fina... Read Full Bio