You might have heard the terms and futures and options in the financial market, and might have interchanged one with another, but there are some differences between them.
As we are aware that both futures and options are financial tools, used by the investor in the stock market industry. Futures and options are contracts between the buyer and seller with high earning potential.
If you will be clear with the difference between futures and options contracts then, you can better decide which trading tool is best for you.
First, we will understand the meaning of future contracts and Option contact, then futures and options differences, so that you can understand them and can make a better decision.
Future contracts details:
Future contracts can be said as the understanding/ agreement between two parties/people or consider seller and buyer. In this contract, both buyer and seller guarantee each other to transact a monetary resource or any asset on some later day at a fixed price.
These contracts are bound to be executed legally, and thus must be performed on a fixed date. The contract must be executed and either cash or assets must be transferred to the buyer.
These contracts can be transferred to someone else and include four major components - Price, Buyer, Seller, and the date of transaction. When the futures contracts are executed on the platforms such as NSE, BSE, NYSE, or any alike, then the futures contract may have commodities, Stocks, Assets, Currencies, etc.
This trade happens between the two mindsets of the people; the seller thinks the price will fall and I will not get any profit, while on the other hand, the buyer thinks that the price may increase and he can get a huge profit out of it.
Options Contract details:
An option contract is also an agreement between two parties; say buyer and seller for performing a transaction of any underlying security mentioned in the contract at a pre-set price, this price is called the strike price.
The contract can be executed on the expiry date or before that date. This contract allows the buyer to buy the underlying asset or sell the underlying asset on or before the expiration date.
So, we hope you must now be clear with what the future and option contract is, let us now move towards understanding the major difference between them.
We can categorize the difference in the below ways, the obligation to execute the contract, the risk involved, the choice of advance payment, and the execution of the contract. Let us check them all.
Obligation:
As we have seen, a future contract is legally undertaken between the parties, seller, and buyer. Thus the buyer is obliged to buy the underlying asset on the date mentioned in the contract.
Whereas, in the option contract, there is no such obligation involved on both sides, neither the buyer is obliged to sell, nor the seller is obliged to sell, if they find profit in making that transaction, they can choose to transact at a fixed price.
Risk factor:
The futures contract is riskier compared to the option contracts, understand why?
Let us say, the price or value of the security moves against what they thought, still they are bound to purchase it, thus, they may incur a huge loss.
On the other hand, the option contract has got a bit of relaxation here; if the value of an asset falls from the agreed price, they can opt themselves out of the contract and are not obliged to execute the contract. So, they can prevent the loss.
Advance payment opportunity: In future contracts, the buyer has to pay some premium amount to enter into the contract, but he is also bound to pay the full agreed price on the expiry date.
The premium paid by the buyer allows him to opt-out of the contract if the market is against him at the cost of the premium paid. It means that if he wants to opt-out of the contract, he has to lose the amount paid as a premium.
In option contracts also there is some amount of commission to be paid by the buyer.
The execution of the contract:
A futures contract must be executed on the date agreed or mentioned in the contract.
While in the option contract, the contract can be executed any time before the expiry date or also on the date of expiry. So, the buyer can choose when he wants to buy, according to the market conditions.
Let us go through the below table to remember the difference:
Options contract Vs. Futures contract
Conclusion
We hope this article has cleared all the queries you might have in your mind regarding the difference between futures and options contracts. This difference table of options contract vs. futures contract will help you choose or enter into the contract wisely and will help you understand the risk and opportunity associated with it.
As we know the financial market is subject to risk on individuals, we can help you understand the concept, the final call lies on your division. If you want to know more on any topic, you can drop a comment, we will surely help you out with that. Thank you.