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Difference Between Futures and Options

Among many tools in the world of the stock market, two very important ones are widely used by investors. These two tools are futures and options. These are closely related to the contracts that are exchanged between buyers and sellers of an asset. These two are very different from each other even though they look similar.

Futures vs Options

The main difference between Futures and Options is that in futures contracts, the holder is obligated to buy the asset on the fixed future date, whereas in an options contract, there is no such obligation on the buyer to purchase. There are many similarities between the futures contract and options contract, but they also differ on a lot of bases.

Futures and Options

The futures contract is a very well known financial contract between investors. It is mostly preferred by speculators and arbitrageurs. The buyer of the futures contract is obligated to honour the contract and has to make the purchase on the fixed future date irrespective of any circumstance related to security.

The options contract is yet another financial contract that is very popular among investors and is mostly preferred by hedgers. In this contract, there is no application on the buyer of the acid to make the purchase. If the buyer chooses not to purchase the designated date, then he is free to do so.

Comparison Table Between Futures and Options

Parameters of ComparisonFuturesOptions
Contract ObligationThe buyer is obligated to honour the contract.There is no obligation on the buyer.
SellerIf the right is exercised by the buyer, then the contract seller is obligated to buy/sell.If the buyer chooses to buy then the seller is obligated to sell the contract.
MarginA high margin payment is required.Low margin payment is required.
Prefered byIt is mostly preferred by arbitrageurs and speculators.It is mostly preferred by hedgers.
Profit and LossUnlimited profit and unlimited loss.Unlimited profit and limited loss.

What is Futures?

The futures contract is a very important tool in the world of the stock market which is closely related to financial investments. In the futures contract, the two parties who are involved in the buying or selling of an asset have an agreement related to that time after purchasing the asset along with the price. There is a compulsion on the buyer in the futures contract to buy the asset on the exact future date, which was specified in the agreement.

There is also a risk related to the futures contract. The risk is that the holder of the futures contract is bound to make the purchase of the asset on the designated future date irrespective of the security moving against them. There is a chance of unlimited profit in the futures contract but also that of unlimited loss. Therefore it becomes a bit risky to invest in a futures contract. One good thing about the futures contract is there is no upfront cost. The buyer is but ultimately bound to buy the asset on the fixed date that was agreed while designing the contract. The futures contract is seen to be generally preferred by speculators and arbitrageurs. Also, there is a higher margin payment requirement in the futures contract.

What is Options?

The options contract is yet another financial investment tool widely used by investors in the stock market while trading. It is best to know the clear difference between the futures contract and options contract to choose which one is the best for the investor. Unlike the futures contract, there is no application on the buyer to buy the asset on any fixed date. The bi is completely free to purchase the asset at a pre-agreed price.

The options contract has a few advantages and therefore appears a bit more beneficial and safe than the futures contract. There is a possibility of unlimited profit in the options contract with just limited loss. Although, the buyer needs to make an advance payment in the options contract. But making this advance payment gives the buyer a privilege to choose whether they want to buy the asset on the agreed date or not. The options contract is mostly preferred by hedgers, and it also requires a very low margin payment. The buyer in the options contract is also free to execute the contract whenever they want, but it should be before the date of expiry.

Main Differences Between Futures and Options

  1. In a Futures contract, the buyer is obligated to honour the contract, whereas, in an Options contract, there is no obligation on the buyer.
  2. In a Futures contract, if the right is exercised by the buyer, then the contract seller is obligated to make the purchase. On the other hand, in an Options contract, the buyer can choose whether to move forward with the purchase or not.
  3. A high payment margin is required in a Futures contract, and a low payment margin is required in an Options contract.
  4. The Futures contract is mostly preferred by arbitrageurs and speculators, while the Options contract is mostly preferred by hedgers.
  5. There is unlimited profit and unlimited loss in the Futures contract. In the Options contract, there is unlimited profit and limited loss.

Conclusion

Anyone who is deciding to invest in the stock market must study all the aspects of a healthy investment. The futures contract and options contract must be understood thoroughly before moving on with making a choice. There are many rules and regulations to be followed while investing in a stock market, and it is better to contact someone with complete knowledge about the same before investing in any area. A good observation of profit and loss statistics along with conditions of selling or buying an asset can help investors go a long way with their investments and prove beneficial in the long run. Also, one must be careful about fraud and fake policies.

References

  1. https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261.1985.tb02384.x
  2. https://search.proquest.com/openview/9670211fbeec5a25da7d12fce203462b/1?pq-origsite=gscholar&cbl=48242
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