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Similarities And Differences Between Futures And Options Contracts
Futures and options are essentially trading contracts involving a buyer, a seller and an underlying asset. These contracts typically mention the asset being traded, a fixed date to carry out the trade (in future), and a fixed price at which the underlying asset is to be traded. Let’s understand what are futures and options and the similarities and differences between these two investment instruments.
Futures vs Options – The Definitions
An options contract is a contract under which the owner of the underlying asset has the choice or ‘option’ to buy/sell the underlying asset at the predetermined future price on a fixed, predetermined date. The owner is not obligated to carry out the trade and may decide against buying or selling the underlying asset by exercising the ‘call’ or ‘put’ option for buying or selling the asset respectively.
A futures contract is one where the buyer or seller of the underlying asset is obligated to buy/sell the asset at a predetermined price on a fixed future date. The trade has to be honoured even if it means that the buyer/seller has to buy/sell the asset by incurring a loss.
Futures and Options Contracts – The Similarities
There are three points of similarities between options and futures contracts. They are as under:
• Daily settlements
Both, futures and options contracts are regarded as exchange traded derivate contracts which are traded on the major Stock Exchanges in India, namely the National Stock Exchange and the Bombay Stock Exchange. Both types of contracts are subjected to daily settlements.
• Underlying assets
Another similarity between these contracts is the underlying assets covered under them. In case of both, futures and options contracts, financial products like stocks, bonds, indices, currencies, commodities etc., serve as underlying assets
• Trading accounts
In order to trade in futures or options, traders are required to open a margin account to carry out the trades. Also, they need to deposit a certain percentage (an initial margin) and premiums respectively, before trading commences.
How are Futures and Options Contracts Different?
Here are the major points of differences between futures and options trade.
• The obligation clause
Traders dealing in futures are obligated to honour the terms of the contract i.e. they are obligated to buy or sell the underlying asset even if it means that they have to incur losses. On the other hand, traders dealing in options are not obligated to buy/sell underlying assets and they can get simply exercise the call or put option if they don’t want to buy or sell the asset respectively.
• The contract execution clause
In case of futures trades, the contract is executed and expires on the date mentioned in the futures contract. Option traders, on the other hand, can execute the contract before the agreed-upon expiration date, if they so choose.
• Risks assumed vs profit
Future trading is considerably more risky as compared to option trading, where the trade can limit the risks assumed by exercising the call and put options. However, the chances of incurring profits are higher with future trading, which cannot be said for options.
• Hedging against risk
An options contract allows the trader to evade price fluctuation risks in case they decide to sell their assets whereas futures traders have no choice but to honour the trade as per the contract terms.
Final Word: As is evident, trading in futures vs options comes with its own set of advantages and disadvantages. You must consider your risk appetite before you begin investing. Futures trades are ideal for high-risk investor but if you have a medium risk appetite, it is best to stick to option trading
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