Difference Between Futures and Options

Options and futures are two varieties of derivative instruments. This implies that both instruments do not have any intrinsic value. Instead, they attain their value from underlying assets such as commodities, currencies, stocks, etc.

You speculate on potential price fluctuations when you trade in stocks, futures, or options. If the prices do not move in your preferred direction you may lose a significant amount invested, as it involves leverage and taking high positions.

That is why it is essential to understand the futures and options differences.

How are futures and options different?

The right to buy or sell a certain asset at a set price on a defined future date is known as a futures contract.

On the other hand, options grant the right to purchase or sell a certain financial instrument at a set price (known as the strike price) on a future specified date but without any obligation of doing so.

Suppose you think that the price of “XYZ company”, which is trading at Rs. 1000, will go up. So, you buy a futures contract at Rs. 1000.

If the share price appreciates, you will profit. However, if the price goes below Rs. 1000, say Rs. 900, you will make a loss.

In contrast, in a call option, you will pay a premium amount and if the price falls below your strike price, you can choose not to exercise the contract and you will only lose the premium amount. This is an inherent advantage of trading options.

Where are options and futures traded?

Both options and futures contracts are standardised contracts traded on markets like the BSE and NSE. This is usually facilitated by a broker. A margin account with a broker is necessary to trade options or futures.

Investors use futures and options strategies to hedge their portfolios or make profits based on market conditions.

Types of options

In a futures contract, there is no type. However, in an options contract, there are two types of contracts.

  • Call options:

    The right but not the obligation to buy a financial instrument on or before the expiry date at the pre-set strike price.
  • Put options:

    The right but not the obligation to sell an asset on or before the expiry date at a pre-set strike price.

Moreover, a call option is used when prices are anticipated to rise. When prices are expected to decrease, a put option is used.

Futures vs options: which is better?

Futures and options have gained tremendous popularity with investors over the past few years. However, some differences between options and choices of futures are listed below to make a wise decision.

Options

Futures

Obligation In an options contract, the holder is not obligated to buy/sell the asset. In contrast, the buyer is obligated to buy/sell the asset in a futures contract.
Risk Since traders are not obligated, they carry lower risks. But an option seller may carry higher risks. Due to the obligation, they carry higher risks.
Premium In an options contract, the buyer will have to pay a premium upfront. Conversely, the buyer does not have to pay a premium upfront in a futures contract.
Profit or loss Though the profit or loss could be unlimited, it reduces the risk of losing money. In a futures contract, there could be unlimited profits and losses.

Important options and futures terms

In an options contract, the key terms to understand are the strike price (i.e., the price at which the underlying financial instrument can be bought/sold), the premium (i.e., the option’s cost for the holder), and the expiration (i.e., the option’s settlement and expiration date).

In a futures contract, the basic terms are exercise price/futures price (i.e., the price of the asset that will be paid in the future), long (i.e., the trader who has purchased the futures contract) and short (i.e., the trader who is selling the futures contract).

Difference between futures and options in terms of liquidity, price and value

Compared to options contracts, futures contracts are more liquid. Regarding price, futures contracts often cost less than options because they are less volatile, and you don’t have to pay an upfront premium as well.

Futures and options contracts lose value with every day that passes. As options approach their expiration date, this phenomenon known as time decay tends to intensify.

What similarities exist between options and futures?

Option and future contracts are exchange-traded derivative contracts trading on stock exchanges like the NSE and BSE and are subject to daily settlement. Moreover, traders need a margin account with the broker for options and futures.

Finally, both contracts have the same underlying financial instruments, such as currency, stock, commodities, bonds, etc.

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Frequently Asked Questions (FAQs)

A futures contract has a higher leverage than an option contract. Furthermore, a futures market has higher liquidity, which contributes to relatively low spreads.

Typically, futures are less expensive than options because they are less volatile.

Futures offer various advantages over options, including the fact that they frequently utilise more margin, are more liquid and are simpler to understand and value. However, they also carry risks. Options have their own set of benefits too, as option traders are not obligated to buy or sell at the expiration date.

Since futures are correlated with asset prices and volatility, they are often riskier. Conversely, options respond to changes in the price of the underlying asset in a different way and provide a greater opportunity to adjust and limit losses.

An options contract has many pros compared to a futures contract; one benefit is that it limits the loss to the premium paid.

Options contracts are more flexible than futures. However, understanding futures contracts are comparatively complex and involve significant volatility.