What is the difference between futures and options?

Posted By:
Subscribe to GoodReturns

What is the difference between futures and options?
Before proceeding to know the key differences between futures and options, let us know what exactly is futures and options. Futures is a derivative instrument whose value is derived from some underlying asset, including stock, commodity, index etc.

Typically, futures is a standardized financial contract as per which two parties into the contract agree to transact a financial instrument or physical commodity of standardized quality and quantity at a particular price agreed upon today for delivery and payment at a defined future date.

Options on the other hand i.e. also a derivatives instrument gives the buyer of the option the right but not the obligation to transact in the underlying asset at an agreed price on or before a specified future date. Buyer of the option pays a premium amount to the seller. Depending on the transaction, option is of two types:

Call option : In this contract, buyer of the option is given the right to buy some underlying asset at a particular price.

Put option : In this contract, buyer of the put option is given the right to sell some underlying asset at a particular price.

Table below lists down some of the fundamental differences between futures and options :

Point of difference Futures Options
Difference in obligation to comply with the terms of the contract In a futures contract, obligation lies with both the seller and the buyer to settle the terms of the contract before the expiry date Buyer of the options contract is given the right but not the obligation. However, seller is responsible to comply with the contract if the buyer exercises the terms.
Cash Outflow Upfront margin is required for purchasing futures contract, so cash outflow is usually large In case of options, only premium amount is required to be paid that results in low cash outflow. Also, it is the maximum amount that an option purchaser can lose in case of adverse price movement
Degree of profit and loss Profit and loss potential is unlimited. Profit potential is unlimited while scope of loss for the buyer of call/put is limited
Method of profit realization Profits in futures position are marked-to-market on a daily basis Going to the market and taking opposite position or exercising the option or wait until the maturity of the contract for realizing the difference between asset price and strike price
Purpose Speculate or hedge risk and also to obtain physical delivery of underlying asset in future period of time Primarily used as hedge instruments

GoodReturns.in

Story first published: Friday, September 13, 2013, 16:21 [IST]
Please Wait while comments are loading...
Company Search
Enter the first few characters of the company's name or the NSE symbol or BSE code and click 'Go'

Thousands of Goodreturn readers receive our evening newsletter.
Have you subscribed?