Options and futures are both trading products that sound very similar, but when it comes to practicing them, you will find there are several differences between the two.
To understand these differences, we should first explain what they are and then take a closer look at what sets them apart from each other.
What are Options?
Options are contracts that give the buyer the right instead of the obligation to buy or sell an underlying stock at a specific price point on or before a certain date. They don’t represent any ownership and are considered a much lower risk.
Options have two categories: call options and put options. A call option means someone has the right to buy the stock at the strike price, while the put option is the right to sell. Option buyers can sell to see the profits from the transaction, but the call option is limited to the premium paid.
What are Futures?
Futures are the legal agreement to buy or sell at a predetermined price point at a specified time in the future. This agreement is between parties that are not known to each other, and the asset transaction is often a commodity or financial instrument. Futures also don’t offer much in the way of flexibility once the contract has been opened.
Options Versus Futures
One of the biggest differences between options and futures is that the future is an obligation while an option is a right. However, both parties face certain risks when it comes to futures because the price may begin to move against them. This kind of agreement is made most often when a company finds that they have to sell or buy the product no matter what and want to be able to try and lock in a price. For options, the buyer has a limited risk while the seller has a much more significant chance of risk.
Futures contracts also differ from options because they are usually much larger than default options contracts. With the larger size for futures contracts also comes higher risks. Since options contracts are generally much smaller so more options can be purchased at one time.
You will also find that futures are more easily understood even though they carry more of the risk for the investor.
Receiving Gains on Options and Futures
When receiving your gains on an option, you can do so in one of the following three ways:
- Exercise the option when it is deep in the money
- Go to the market and take the opposite position
- Wait until expiry and collect the difference
When receiving your gains on futures:
- Automatically market daily and is attributed to the account at the end of each trading day
- Go to the market and take the opposite position
When choosing between options and futures, you need first to ask yourself just how much risk you are willing to contend with when it comes to the investment strategies you plan to use. While options trading provides less of an upfront risk, you lack the obligation to exercise the contract.
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Important Futures Trading Disclaimer
Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment. You must review customer account agreement prior to establishing an account.
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