Futures and options are well-known financial derivatives, which implies that the prices of these investment instruments are derived from the underlying asset that they follow. Derivative instruments such as futures and options are essentially used for limiting risks. The futures and options strategy would be great for an investor who has exposure in the underlying markets, as they can lessen the risks by trading the asset to the relevant derivative market.
Based on the volatility from the underlying asset that is being traced, trading of futures give higher opportunities to traders and particularly speculators to make significant profits from trading the equivalent futures or options. Futures and options are two widely popular derivative markets and even if one of them falls, the market statistics for the other one would also drop.
Let’s have a look at the top differences between the futures trading and options trading.
Futures is an agreement between two participants to purchase or sell an asset at a specified time in the future at a predetermined price. Here, the buyer is compelled to purchase the asset on the stipulated date. An options agreement, on the other hand, gives the buyer the freedom to purchase the asset at a set price. However, the buyer is not obligated to endure the purchase. Though, if the buyer chooses to acquire the asset, the seller is bound to sell it.
The futures holder is forced to purchase on the expected date even if the contract goes against them. For instance, assume that the market value of the investment medium falls below the price stipulated in the contract; however, the buyer will nevertheless have to purchase it at a price accepted upon earlier and acquire the losses. The buyer in an options agreement has a benefit here. If the asset price drops below the agreed-upon value, then the buyer can withdraw from buying it, which restricts the loss acquired by the buyer. A futures contract could produce endless profit or loss, whereas an options contract can make an infinite profit, but with less potential for loss.
In a futures contract, no advance cost has to be paid by the buyer. However, the buyer is bound by law to pay the accepted price for the asset in the future. In case of an options contract, the buyer has to pay a premium amount, which grants the buyer the right not to purchase the asset in future if it shifts towards a loss or becomes less profitable. If the options contract owner chooses not to purchase the asset, the premium he paid will not be refunded.
A futures contract is fulfilled on the date accepted upon by both the parties in the contract. The buyer acquires the underlying asset, at a profit or loss on this date. Alternatively, an options contract holder can execute the agreement at anytime prior to the date of expiry. Thus, an investor is free to purchase an asset whenever they feel the circumstances are profitable.
A major difference between futures contracts and options contracts is the process by which the parties obtain the profits. The revenues on a future are automatically recorded on the market daily. This means that the change in the valuation of the contract is credited to the holder of the futures accounts at the end of each trading day. However, a futures contract owner can receive the profits by going to the respective market. In contrast, options contract can be earned with three different ways; utilising the option when it is deep in the money, going to the market and taking the opposing position, or waiting till the expiry of the contract and receiving the difference between the strike price and initial asset price.
The futures contract allow little to no flexibility once an agreement is signed upon by both the parties. As mentioned earlier, the buyer purchases the obligation and right for fulfilment once a position is initiated. On the other hand, stock options present investors with both the freedom to buy and sell stock through call and put option respectively. However, stock options also give the trader an opportunity to be flexible with their futures and options strategies, which is unavailable with futures trading.
As discussed in the points mentioned above, both futures and options are derivatives contract, which can be customised as per the specifications of both the parties. Options agreement can decrease the number of losses unlike futures agreement; however, futures offer the protection of a contract being executed at a particular date. As a buyer, you must look at all the pros and cons of both the derivates and choose one that suits your financial situation.