Future and options are the form of extended trade derivatives. Derivatives are the financial instruments that derive their value from an underlying security or asset like share, debt instrument, currency, gold or a commodity. Investing in futures and options can help you tomake your financial infrastructure secure.
Let us try to understand them individually first:
A ‘Future’ is a contract for buying or selling an underlying asset at a specified price at a given time in future. Equity stocks, indices, commodities and currency are a few types of future contract.
Future contract is usually bought by the people who do not have the money to buy the contract now but they can arrange the same at a specified date. Many traders use future contracts for arbitrage or buying a stock at a lesser price in the market and selling it at a higher price in the futures market.
In the case of futures contract, the obligation is both on the buyer and the seller to accomplish the contract at a certain date.
‘Options’ contracts are the instruments that lets the holder of the options contract to buy or sell the underlying asset at a fixed price.
An option can either be a ‘call’ option or a ‘put’ option. In a call option, the buyer buys the asset at a given price or ‘strike price’. The holder of the call option can demand sale of the asset from the seller and the seller has to oblige. In a ‘put’ option, the buyer can sell the asset at the ‘strike price’ to the buyer and yet again, the seller has to oblige.
The buyers can look for an option chain which lists the options prices of all of the options for a particular stock. An Option gives the buyer the right but not the obligation while the seller has an obligation to comply with the contract. But in the case of a futures contract, there is an obligation for both the buyer and the seller.If the buyer of options chooses to buy, the seller has to oblige. But, in case of the futures contract, it is binding on both the parties and they have to settle the contract before the expiry.
The primary difference between options and futures are in the obligations. While an option gives the buyer the right and not the obligation to buy or sell a certain security at a specific price at a given time, but the futures contract gives the buyer the obligation to purchase a specific asset and the seller to sell that asset at a specific date.
If you are a buyer of futures, there is an unlimited profit and unlimitedloss too but if you buy a Call or a Put Option, the loss is limited but the profit is unlimited.
Future requires higher margin payments as compared to options while options chain require lower margin payment as compared to futures. While future is generally preferred by speculators and arbitrageurs, options is preferred by hedgers.
For more on Stock Markets and Futures & Options, visit BloombergQuint.