Futures and options are two types of financial derivatives contracts that derive their value from market movements for the underlying index, security, or commodity. They are contracts signed by two parties for trading a stock asset at a predetermined price on a later date. Both futures and options allow an investor to buy an investment at a specific price by a specific date, but there are important differences in the rules for options and futures contracts, and in the risks they pose to investors.
Futures Trading
- Futures are contracts that obligate the buyer to purchase a specific asset, and the seller to sell and deliver that asset, at a specific future date.
- Futures contracts are obligatory, meaning that the parties to the futures contracts for commodities are typically obligated to make and accept deliveries on the settlement date.
- Futures trading requires a trader to keep a certain percentage of the future value with the broker as a margin to take the buy/sell position.
Options Trading
- Options are contracts that give the buyer the right, but not the obligation, to buy (or sell) an asset at a specific price at any time during the life of the contract.
- Options contracts provide a buyer with a choice to buy or sell the underlying asset if he/she profits from a trade.
- Options positions may be traded and closed ahead of expiration, and investors may choose not to exercise their options.
In summary, futures and options are two types of financial derivatives contracts that allow investors to speculate on market price changes or to hedge risk. Futures contracts obligate the buyer to purchase a specific asset, while options contracts give the buyer the right, but not the obligation, to buy or sell an asset at a specific price at any time during the life of the contract.
