Difference between Future & Options

Harnessing Market Opportunities: Leveraging Futures And Options For Profitable Investing

Hey there, fellow investors and trading enthusiasts! If you're eager to explore exciting ways to make profitable investments, then you're in the right place. Today, we're diving headfirst into the world of Futures and Options—the dynamic duo of the trading realm. These financial instruments have the potential to unlock a whole new level of market opportunities and help you turbocharge your returns.

So, whether you're a seasoned trader or just starting on your investment journey, understanding the ins and outs of Futures and Options is key to making those savvy trading decisions. Ready to embark on this enlightening adventure? Let's buckle up and discover the difference between Futures and Options and how they can be your secret weapon in harnessing market opportunities for profitable trading.

Definition and Basics of Futures Contracts

Futures contracts are derivatives to purchase or sell underlying assets like stocks, commodities, ETFs, etc., by a future date at a specific quantity and price. The contract clearly mentions these specifications. Moreover, regardless of the asset's current market value, both parties must fulfill the agreement. Futures contracts have high liquidity due to trade on a stock exchange, which sets the minimum amount and margin requirement a trader must deposit for trading. All in all, it secures an asset’s price to protect it from market volatility.

For example, let's say an investor buys a futures contract for 100 shares of Company X at a price of INR 100 per share with a delivery date three months from now. This contract obligates the trader to purchase the shares at the agreed-upon price, regardless of the actual market price at the delivery date. Conversely, the seller of the futures contract is obligated to deliver the shares to the buyer at the specified price and date.

Definition and Basics of Options

Options give you the right to purchase or sell an asset at a predetermined price during the contract term. As an investor, you have the right to choose whether you want to exercise the option or not. All in all, it is a financial derivative that does not give you the asset’s ownership unless you exercise your shareholder rights and buy the stock. It is largely based on the value of the index future, commodity, or underlying stock.

For example, let's say an investor purchases a call option on Company Y's stock with a strike price of INR 100 and an expiration date of one month. If, during that month, the stock price rises above INR 100, the investor can exercise the option and buy the shares at the predetermined price, even if the market price is higher. However, if the stock price remains below INR 100 or falls, the investor is not obligated to exercise the option and can let it expire.

Key Difference Between Futures and Options

These are some major points of difference between Futures and Options including:

• ● Obligations and Rights

Since a Futures contract is obligatory to the parties, both must honour the agreement on a predetermined date. It eventually locks the buyer into a contract. On the other hand, an options contract gives you the right to trade an asset at a fixed rate, but you have no obligations to purchase or sell the security. However, if the buyer decides to purchase the asset, the seller has no right to deny it.

• ● Contract Flexibility

You must execute a Futures contract on the predetermined date mentioned in the agreement. That means you must purchase the underlying asset on this date. Meanwhile, in an Options contract, you execute the purchase any time before the contract's expiry date. So, you can buy the asset whenever it’s the right time and conditions are favourable.

• ● Risk and Reward

A Futures contract binds you to buy the asset on a predetermined date even when the security is against you. That means if the asset’s market value falls below the contract price, you will still need to purchase it and incur a loss. On the other hand, an options contract is less risky for the buyer. If the asset price falls below the contract price, you can opt out and avoid the loss.

• ● Margin Requirements

Margin is the upfront amount you must pay at the time of entering a contract. The margin amount may vary according to the asset and total transaction amount. The broker uses this margin as protection against any loss you incur while making a transaction. In a Futures contract, you do not need to pay the total value upfront. Instead, the initial margin is a percentage of the price. On the other hand, in an Options contract, no margin is involved, but you have to pay a premium that allows you to refuse the purchase if the transaction becomes unattractive in the future. However, you will lose the premium amount paid if you decline the transaction.

• ● Level of Profit or Loss

Due to its binding nature, a Futures contract can bring you substantial profit or loss. You must buy or sell the asset on a specific date, irrespective of its current market price. Meanwhile, you can enjoy profit with an Options contract but minimise the chance of potential loss by opting out of buying when the price is low.

• ● Advance payment

A Futures contract does not require you to pay any upfront cost at the time of entering, but you must pay the asset price on maturity. However, in the Options contract, you must pay a premium. It is necessary to enjoy the privilege of not buying the asset in the future if it loses its value. In case you choose not to purchase an asset, the premium amount is all you will lose.

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Conclusion.

Understanding the difference between Futures and Options is paramount when it comes to harnessing market opportunities for trading. While both instruments offer unique advantages and strategies, Futures provide a more direct and binding contract. By grasping these distinctions, investors can tailor their approach to suit their goals and risk tolerance.

Disclaimer: Trading in Futures and Options involves substantial risk and is unsuitable for all investors. Past performance is not indicative of future results. Consult a financial advisor before engaging in such trading activities.