Options and Futures Trading - Similarities and Differences

The phrase “options and futures” is commonly used together. In a way, “options and futures” are like financial Siamese twins. There are very distinct differences between options and futures that the experienced investor would be aware of and would keep in mind.

Both options and futures are considered derivatives because they do not have any wealth on their own as a single asset. Instead, these instruments gain their wealth from the value of the contract they are associated with. They do have a distinct difference, however. Both are contracts that are legally binding between two parties, but the contracts themselves are what define the differences.

If you have a futures contract, you as the buyer have the obligation to purchase an asset at an agreed-upon date. The seller will have to deliver the goods at this time. If the futures holder cancels his position before the expiration date, the delivery of the goods will be cancelled as well.

An options contract, by comparison, gives the buyer only the right, not the obligation, to purchase (call) or sell (put) an asset. The holder will be allowed to either exercise their right or else let the option expire and simply lose their premium.

An investor can get into a futures contract without putting any funds into the contract (excluding the commission fees that go with every transaction). An options contract, however, always carries a cost associated with it called the premium. Futures contract buyers will typically have to put down a deposit as well but the futures contract itself does not cost anything, whereas the options contract does.

On the other hand, futures contracts have a bigger investment in the asset from a legal perspective. The contract will require the buyer to purchase an asset or goods by a certain date or to sell the contract by another party. The financial obligation is possibly much larger. The risk with options contracts compared to futures contracts is much lower since options investors will only lose their premium cost should the deal not work out favorably for them.

Few investors will actually take all of the goods that come with the futures contract. Who wants 1,000,000 barrels of oil sitting around their living room? Instead, the investor will negotiate to have their goods properly pushed to another agent who will be responsible for handling the actual buying and selling of the physical goods. Of course, you can also have a futures contract on non-physical goods, such as bonds or index futures.

Only a small percentage of options traders will deliver the stock shares, bond certificates or other investment commodity. Employees will take part in options as part of their employee compensation package, which can become a significant number of investors depending on how big the company itself becomes. Both futures and options contracts can carry a large number of risks, but they can be valuable for the high amount of leverage they offer and the ability to control all of the funds that you invest in.

         

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