An options contract gives an investor the right, but not the obligation, to buy (or sell) shares at a specified price at any time before the contract's expiration. By contrast, a futures contract requires a buyer to purchase the underlying security or commodity—and a seller to sell it—on a specific future date, unless the holder's position is closed earlier.
Options and futures are two varieties of financial derivatives investors can use to speculate on market price changes or to hedge risk. Both options and futures allow an investor to buy an investment at a specific price by a specific date. But there are important differences in the rules for options and futures contracts, and in the risks they pose to investors.
Key Takeaways
- Options and futures are two types of derivatives contracts that derive their value from market movements for the underlying index, security or commodity.
- An option gives the buyer the right, but not the obligation, to buy (or sell) an asset at a specific price at any time during the life of the contract.
- A futures contract obligates the buyer to purchase a specific asset, and the seller to sell and deliver that asset, at a specific future date.
- Futures and options positions may be traded and closed ahead of expiration, but the parties to the futures contracts for commodities are typically obligated to make and accept deliveries on the settlement date.
What's The Difference Between Options And Futures?
Options
Options are based on the value of an underlying stock, index future, or commodity. An options contract gives an investor the right to buy or sell the underlying instrument at a specific price while the contract is in effect. Investors may choose not to exercise their options.
Options are financial derivatives. Option holders do not own the underlying shares or enjoy shareholder rights unless they exercise an option to buy stock.
Options contracts for stocks typically provide the right to buy or sell 100 shares of the stock at the specified strike price before the contract expiration date, and the price of the option is known as its premium.
In the U.S., the equity options market is open from 9:30am - 4:00pm EST; the same as normal stock trading hours. Options exchanges are also closed on holidays when stock exchanges are closed.
Types of Options: Call and Put Options
There are only two kinds of options: Call options and put options. A call optionconfers the right to buy a stock at the strike price before the agreement expires. A put option gives the holder the right to sell a stock at a specific price.
Let's look at an example of each—first of a call option. An investor buys a call option to buy stock XYZ at a $50strike price sometime within the next three months. The stock is currently trading at $49. If the stock jumps to $60, the call buyer can exercise the right to buy the stock at $50. That buyer can then immediately sell the stock for $60 for a $10 profit per share.
Other Possibilities
Alternatively, the option buyer can simply sell the call and pocket the profit, since the call option is worth $10 per share. If the option is trading below $50 at the time the contract expires, the option is worthless. The call buyer loses the upfront payment for the option, called the premium.
Meanwhile, if an investor owns a put option to sell XYZ at $100, and XYZ’s price falls to $80 before the option expires, the investor will gain $20 per share, minus the cost of the premium. If the price of XYZ is above $100 at expiration, the option is worthless and the investor loses the premium paid upfront.
Either the put buyer or the writer can close out their option position to lock in a profit or loss at any time before its expiration. This is done by buying the option, in the case of the writer, or selling the option,in the case of the buyer. The put buyer may also choose to exercise the right to sell at the strike price.
Futures
A futures contract is the obligation to sell or buy an assetat a later date at an agreed-upon price. Futures contracts are a true hedge investment and are most understandable when considered in terms of commodities like corn or oil. For instance, a farmer may want to lock in an acceptable crop price in case market prices fall before the crop can be delivered. The buyer also wants to lock in a price to protect against a subsequent rise in prices.
Examples
Let's demonstrate with an example. Assume two traders agree to a $7 per bushel price on a corn futures contract. If the price of corn moves up to $9, the buyer of the contract makes $2 per bushel. The seller, on the other hand, loses out on a better deal.
The market for futures has expanded greatly beyond oil and corn. Futures can be purchased on an index like the , and on individual stocks in some jurisdictions. (Single-stock futures have not been available in the U.S. since 2020.) Buyers of a futures contract are not required to pay the full value of the contract up front. Instead, they cover a percentage of the price as an initial margin.
For example, an oil futures contract is for 1,000 barrels of oil. An agreement to buy an oil futures contract at $100 requires the buyer to risk $100,000. The buyer may be required to pay several thousanddollars up front, and may be required to increase that commitment later if oil prices subsequently drop.
Futures markets primarily serve institutional investors. These may include refiners seeking to hedge crude costs or cattle producers seeking to lock in feed prices.
Who Trades Futures?
Futures markets serve commodity producers, commodity consumers, and speculators. Futures contracts can protect buyers as well as sellers from wide price swings in the underlying commodity.
They also cater to institutional as well as retail traders seeking to profit from expected changes in market prices for the underlying security or commodity. Financial speculators typically don't intend to acquire the underlying commodity when the contract is settled, and are likely to sell their position beforehand.
Futures trading hours may differ from stock and options markets. Normal trading hours are often 8:30a.m.–3:00p.m., with electronic trading on the CME's Globex platform overnight from 5:00p.m.–8:30a.m. CT. Some futures products trade 24-hours a day on Globex.
Key Differences
Aside from the differences noted above, there are other things that set options and futures apart. Here are some other major differences between these two financial instruments.
Options
Because they tend to be fairly complex, options contracts tend to be risky. Call and put options can be equally risky. When an investor buys a stock option, its risk is defined by its cost, or premium. In the worst case scenario, the option premium spent will be a total loss if the options expire worthless.
However, selling a put option exposes the seller to a loss potentially much larger than the premium gained from a possible decline in the value of the shares underlying the stock option. If a put option gives the buyer the right to sell the stock at $50 per share but the stock falls to $10, the seller remains on the hook to purchase the stock at $50 per share.
The risk to the buyer of an option is limited to the premium paid up front. An option's price fluctuates based on a number of factors, including how far the strike price is from the underlying security's current price, as well as time remaining before expiration. This premium is paid to the seller of the put option, also called the option writer.
The Option Writer
The option writer is on the other side of the trade. Option sellers take on more risk relative to option buyers. Since there is no upper bound to a share price, there is no upper limit to how much the seller of a call option can lose on the rise in the share price. Option sellers may own the underlying stock to limit their risk.
The option buyer as well as the option seller may trade out of the position in the options market.
Futures
Options may be risky, but futures can be riskier still for the individual investor. Futures contracts obligate both the buyer and the seller. Futures positions are marked to marketdaily, and, as the underlying instrument's price moves, the buyer or seller may have to provide additional margin.
Futures contracts require a significant capital commitment. The obligation to sell or buy at a given price makes futures riskier by their nature.
Examples of Options and Futures
Options
To complicate matters, options are bought and sold on futures. But that allows for an illustration of the differences between options and futures. In this example, one options contract for gold on the Chicago Mercantile Exchange (CME) has as its underlying asset one COMEX gold futures contract.
An options investor could have purchased a call option for a premium of $2.60 per contract with a strike price of $1,600 expiring in February 2019. The holder of this call would have had a bullish view on gold and held the right to assume the underlying gold futures position until the option expiration after the market close on Feb. 22, 2019.
If the price of gold rose above the strike price of $1,600, the investor would have exercised the right to buy the futures contract. Otherwise, the investor would have allowed the options contract to expire. Their maximum loss wasthe $2.60 premium paid for the contract.
Futures
The investor might have purchased a futures contract on gold instead. One futures contract has as its underlying asset 100 troy ounces of gold. This means the buyer is obligated to accept 100 troy ounces of gold from the seller on the delivery date specified in the futures contract. Assuming the trader has no interest in actually owning the gold, the contract will be sold before the delivery date or rolled over to a new futures contract.
As the price of gold rises or falls, the incremental gain or loss is credited to, or debited against, the investor's account at the end of each trading day. If the price of gold in the market falls below the contract price the buyer agreed to, the futures buyer is still obligated to pay the seller the higher contract price on the delivery date.
FAQs
An option gives the buyer the right, but not the obligation, to buy (or sell) an asset at a specific price at any time during the life of the contract. A futures contract obligates the buyer to purchase a specific asset, and the seller to sell and deliver that asset, at a specific future date.
Which is a difference between options and futures quizlet? ›
A futures/forward contract gives the holder the obligation to buy or sell at a certain price. An option gives the holder the right to buy or sell at a certain price.
Which is better between futures and options? ›
Futures have several advantages over options in the sense that they are often easier to understand and value, have greater margin use, and are often more liquid. Still, futures are themselves more complex than the underlying assets that they track. Be sure to understand all risks involved before trading futures.
Why are futures better than options? ›
"Futures contracts are usually cheaper than options, particularly when volatility is expensive," she adds. Instead of a premium, futures contracts are purchased with a small down payment on the future trade.
What is futures and options with examples? ›
Futures are obligatory contracts that bind the trader to buy or sell an underlying stock or index at a future date on a pre-set price. Conversely, you can enter a long position by buying an option and paying the premium. The options contract contains a strike price – a future value of an asset.
Which is more risky futures or options? ›
Futures tend to be riskier as they are directly aligned to the asset prices and their volatility. On the other hand, Options react differently to the underlying asset price movements and allow you relatively more time to manoeuvre and curtail losses.
What is difference between future and options and derivatives? ›
Derivatives include swaps, futures contracts, and forward contracts. Options are one category of derivatives and give the holder the right, but not the obligation to buy or sell the underlying asset. Options, like derivatives, are available for many investments including equities, currencies, and commodities.
What is one of the biggest differences between a futures option and a futures contract? ›
The biggest difference between options and futures is that futures contracts require that the transaction specified by the contract must take place on the date specified. Options, on the other hand, give the buyer of the contract the right — but not the obligation — to execute the transaction.
What is the similarity between futures and options contracts? ›
Futures vs options: The key similarities
Both contracts have expiry dates. Both markets provide a way to participate in the underlying asset without owning it. Both provide exposure to a market with a smaller amount of cash than having to buy the position outright.
Is trading futures more profitable than options? ›
The return is much higher in the case of futures options. The risk is also higher because of higher notional value and leverage. But if you know how to trade them futures options is much better to trade with than stock of ETF options!
It is possible to be profitable in online trading for F&O if you get your basics right. This is the basic philosophy of how to trade in futures and options. One of the reasons retail investors get enthused about F&O is that it is a margin business. For example, you can buy Nifty worth Rs.
What is the advantage of options trading? ›
For speculators, options can offer lower-cost ways to go long or short the market with limited downside risk. Options also give traders and investors more flexible and complex strategies such as spread and combinations that can be potentially profitable under any market scenario.
Why do people lose money in futures and options? ›
Traders lose money because they try to hold the option too close to expiry. Normally, you will find that the loss of time value becomes very rapid when the date of expiry is approaching. Hence if you are getting a good price, it is better to exit at a profit when there is still time value left in the option.
Why do people buy futures instead of stocks? ›
What trading futures essentially means for the investor is that they can expose themself to a much greater value of stocks than they could when buying the original stocks. And thus their profits also multiply if the market moves in his direction (10 times if the margin requirement is 10%).
How do you understand futures and options? ›
A Future is a contract to buy or sell an underlying stock or other asset at a pre-determined price on a specific date. On the other hand, Options contract gives an opportunity to the investor the right but not the obligation to buy or sell the assets at a specific price on a specific date, known as the expiry date.
How do you explain futures? ›
Futures are a type of derivative contract agreement to buy or sell a specific commodity asset or security at a set future date for a set price. Futures contracts, or simply "futures," are traded on futures exchanges like the CME Group and require a brokerage account that's approved to trade futures.
What is a real life example of futures? ›
For example, corn farmers can use futures to lock in a specific price for selling their corn crop. By doing so, they reduce their risk and guarantee they will receive the fixed price. If the price of corn decreased, the farmer would have a gain on the hedge to offset losses from selling the corn at the market.
What are examples of futures? ›
There are many "commodities" which have futures contracts associated with them. For example, certain foods, fuels, precious metals, treasury bonds, currencies, and even some exotic ones like semiconductor chips. These allow people to mitigate risk related to their underlying businesses.
What are the safest option trades? ›
Two of the safest options strategies are selling covered calls and selling cash-covered puts.
Which is safe future or option? ›
Where futures and options are concerned, your level of tolerance of risk may be a contributing variable, but it's a given that futures are more risky than options. Even slight shifts that take place in the price of an underlying asset affect trading, more than that while trading in options.
Futures often involve a high degree of risk since they are highly leveraged, with a relatively small amount of money controlling assets of greater value. This means that the amount you can potentially lose is unlimited and may exceed your original deposit.
What are the 4 types of options? ›
There are four basic options positions: buying a call option, selling a call option, buying a put option, and selling a put option. With call options, the buyer is betting that the market price of an underlying asset will exceed a predetermined price, called the strike price, while the seller is betting it won't.
How does an option work? ›
An option is a contract giving the buyer the right—but not the obligation—to buy (in the case of a call) or sell (in the case of a put) the underlying asset at a specific price on or before a certain date. People use options for income, to speculate, and to hedge risk.
What is the meaning of options? ›
What Is an Option? The term option refers to a financial instrument that is based on the value of underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the underlying asset.
What is the difference between option contract and futures contract? ›
A futures contract is executed on the date agreed upon in the contract. On this date, the buyer purchases the underlying asset. Meanwhile, the buyer in an options contract can execute the contract anytime before the date of expiry. So, you are free to buy the asset whenever you feel the conditions are right.
What is the biggest advantage of futures contracts? ›
Low Execution Cost. To own a futures contract, an investor only has to put up a small fraction of the value of the contract (usually around 10%) as margin. The margin required to hold a futures contract is therefore small and if he has predicted the market movement correctly, he receives huge profits.
How would you differentiate a forward contract from a futures contract and an option contract? ›
A forward contract is a private and customizable agreement that settles at the end of the agreement and is traded over the counter (OTC). A futures contract has standardized terms and is traded on an exchange, where prices are settled on a daily basis until the end of the contract.
Do options have more leverage than futures? ›
options. The advantage of trading futures vs options is that you have more leverage. There is some leverage advantage to futures compared to stocks and options and it's a much more liquid market which gives you relatively low spreads. The liquidity also makes it much easy for traders to get their orders filled.
Can futures be sold before expiry? ›
Before Expiry
It is not necessary to hold on to a futures contract till its expiry date. In practice, most traders exit their contracts before their expiry dates.
Are futures cheaper than options? ›
An options contract can never be worth less than $0. Futures contracts, on the other hand, can and do go into negative pricing. This is because futures contract holders are required to buy the underlying asset regardless of market price.
Business owners generally use futures contracts to hedge risk. For example, a corn farmer can use a futures contract to lock in a certain price for their corn months ahead of time. An airline can use futures to hedge against the risk of rising fuel prices. Traders can use futures contracts to speculate.
How does futures work? ›
Futures are a type of derivative contract agreement to buy or sell a specific commodity asset or security at a set future date for a set price. Futures contracts, or simply "futures," are traded on futures exchanges like the CME Group and require a brokerage account that's approved to trade futures.
Can I trade options on futures? ›
Trading options on futures by purchasing puts and calls is a way to capitalize on a fast moving market with a set amount of risk (what you pay for the option) just the same as buying a call or put in an equity option.
Is trading futures harder than options? ›
Where futures and options are concerned, your level of tolerance of risk may be a contributing variable, but it's a given that futures are more risky than options. Even slight shifts that take place in the price of an underlying asset affect trading, more than that while trading in options.
What is the biggest difference between an option and a futures contract? ›
Futures are a contract that the holder the right to buy or sell a certain asset at a specific price on a specified future date. Options give the right, but not the obligation, to buy or sell a certain asset at a specific price on a specified date. This is the main difference between futures and options.
What is an option example? ›
Options are derivatives of financial securities—their value depends on the price of some other asset. Examples of derivatives include calls, puts, futures, forwards, swaps, and mortgage-backed securities, among others.
How do futures work for dummies? ›
Futures are derivative contracts to buy or sell an asset at a future date at an agreed-upon price. Futures contracts allow players to secure a specific price and protect against future price swings. You can buy futures on commodities like coffee, stock indexes like the S&P 500 or cryptocurrencies like Bitcoin.
Can beginners trade in futures? ›
How To Invest in Futures and Options? Futures and options trades do not need a demat account but only need a brokerage account. The preferred route is to open an account with a broker who will trade on your behalf. You can trade in derivatives at the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
Can you lose on futures? ›
Because of the leverage used in futures trading, it is possible to sustain losses greater than one's original investment.
What is better than trading options? ›
For all but advanced investors, stocks are probably the better choice than options at all times, but an easier way to buy them is through stock ETFs. You'll get diversified exposure to a stock portfolio, reduced risk and the potential for nice returns.
An account minimum of $1,500 is required for margin accounts. A minimum net liquidation value (NLV) of $25,000 to trade futures in an IRA.
