Key Takeaways
- Future contracts are financial derivatives that enable parties to speculate on the future price of an underlying asset.
- Options are financial derivatives that grant the holder the right, but not the obligation, to buy or sell an underlying asset before the expiring date.
- Futures contracts involve an agreement to buy or sell an underlying asset at a specific price and date in the future, while options contracts grant the holder the choice to execute the trade at the specified price and date but do not require it.
What are Futures?
Futures contracts are financial derivatives that enable parties to speculate on or hedge against the future price of an underlying asset, such as commodities. Stock or financial instruments. These contracts obligate the buyer to purchase and the seller to sell the asset at a predetermined price on a specified future date.
Futures serve various purposes. Firstly, they provide a means of price discovery and risk management. Secondly, futures are leveraged instruments. Moreover, the futures market operates on centralized exchanges, which enhance liquidity and transparency.
However, future trading involves inherent risk. Futures contracts offer a versatile tool for managing risk and speculation on price movements in various asset classes.
What are the Options?
Options are financial derivatives that grant the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price on or before a specified expiration date. Options provide flexibility and strategic advantages to investors and traders.
Options can serve diverse purposes. For instance, a call option allows an investor to profit from an anticipated rise in the underlying asset’s price without actually owning it.
One notable feature of options is their versatility. Investors can employ various strategies such as covered calls, straddles and iron condors to manage risk or generate income. These strategies can be tailored to market conditions and individual investment goals.
Difference Between Futures and Options
- Futures contracts involve an agreement to buy or sell an underlying asset at a specific price and date in the future, while options contracts grant the holder the choice to execute the trade at the specified price and date but do not require it.
- Future contracts offer less flexibility because they are standardized and are obligated to buy or sell at a specific date and price. In comparison, options provide greater flexibility since the holder can choose whether or not to exercise the contract.
- Future contracts are used for hedging purposes, allowing businesses to manage price risks in commodities, currencies, etc. In contrast, options are commonly used for speculation and provide more strategic possibilities for generating income and managing risk.
- The cost of trading future primarily includes commission and margin requirements, while the cost structure for options consists of the premium paid, which can vary significantly based on market conditions.
- Future markets have set trading hours and may not be available for trading around the clock. At the same time, options are more flexible regarding trading hours and can be traded during regular market hours.
Comparison Between Future and Options
| Parameters | Futures | Options |
|---|---|---|
| Definition | Agreement to buy or sell an underlying asset at a specific price | Grant the holder the choice to execute the trade at a specified price |
| Flexibility | Less flexibility as they are standardized | Greater flexibility as the holder can choose whether to exercise the contract or not |
| Usage | Used for hedging purposes, allowing management price risks | Used for speculation and providing more strategic possibilities for generating work |
| Cost | Primarily includes commission and margin | Premium paid which can vary significantly |
| Market hours | Fixed trading hours | More flexible in terms of trading hours |
- https://www.sciencedirect.com/science/article/pii/0378426695000348
- https://www.jstor.org/stable/3664846
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