Futures and Options: A Quick Comparison

Share:

Futures and options are both very profitable derivatives. They offer various benefits that are distinct, even if the two seemingly appear the same. However, many investors are actually not aware of the main differences of futures and options.

Futures and options embedded on screen


Before we tackle their main differences, let’s first define what derivatives are exactly like.


Futures and Options: What are Derivatives?

When we talk about derivatives, we’re referring to financial securities that sport a value that is based or “derived” from a group of asset or underlying assets.

The derivative is a contract sealed between two or more parties, and they seal the deal based on the underlying assets, whose fluctuations dictate the price of the derivative.

Stocks, bonds, commodities, interest rates, currencies, and market indexes are the most common underlying assets used in derivatives.

Moreover, you can trade derivatives over the counter or on an exchange. What’s the differences between the two?

Over-the-counter derivatives are unregulated. These types of derivatives account for the majority of all derivatives in the market. Meanwhile, exchange-traded derivatives all follow some criteria, which make them standardized.


The Main Differences of Futures and Options

Futures and options are both derivatives, but they sport distinct traits suitable for different kinds of investors. The following explains the main differences between the two.

Rights and Obligations

If you choose to trade futures, both you and the buyer or seller should settle the futures contract no matter how the underlying asset behaves. This is your obligation as a futures trader.

Meanwhile, this is the case for options traders. If you choose to trade options, you also have the right to buy or sell the underlying asset. The difference is that you are not obliged to do this if you don’t want to, hence the name “options.” In addition, the option seller must comply with what the option buyer wants to do.


Risks and Returns

For futures contracts, you can gain or lose unlimited amounts of money. Your likely gains or losses could go way beyond the initial margin paid.

For options contracts, the potential gains and losses are not the same. The potential gain you have if you buy an option can be unlimited. However, your risks as a buyer are only limited to the premium you have paid. Since you have to pay a premium, your potential gain is smaller than that of a futures trader.

Meanwhile, your profits as an option seller is only limited the premium you have received. Considering that the option seller must comply with the buyer’s decision on exercise, your losses may exceed the amount of premium you have received.


Requirements on the Margin

If you are trading futures you must pay an amount for the margin deposit to open a buy or sell position for the contract. Meanwhile, an options trader only has to pay a premium once the contract kicks off and he or she doesn’t have to post a margin.


Final Word

As a trader, you have to know these fundamental differences between futures and options contracts before you dive into them. The best way to learn deeper and more useful knowledge about them, however, is to actually invest in them.



Test your skills in stock trading at FSMSmart! We will provide you with daily market updates and help you stay up-to-date with economic eventsRegister for an account now!

No comments