Futures & Options: Which is The One

Options and futures are two types of financial derivatives that investors can use to speculate on changes in market prices or to hedge risk. Both options and futures allow an investor to buy an investment at a specific price on a specific date. But there are important differences in the rules that govern options and futures contracts, and in the risks they pose to investors.

An options contract gives an investor the right, but not the obligation, to buy (or sell) shares at a specified price at any time before the contract expires. In contrast, a futures contract requires a buyer to buy the underlying security or commodity – and a seller to sell it – at a specified future date, unless the holder’s position is closed out earlier.

Highlights:

• Options and futures are two types of derivative contracts which derive their value from changes in the market for the underlying indices, securities or commodities.
• The buyer has the right, but not the duty, to purchase an asset at a specified price at any time during the life of the agreement.
• A futures contract requires the buyer to purchase a specific asset, and the seller to sell and deliver that asset, at a specified future date.
• Futures and options positions may be traded and closed out prior to expiration, but parties to commodity futures contracts typically have an obligation to make delivery and accept delivery on the settlement date.

Options:

Options are built on the value of an underlying equity, index futures or commodities. An option contract gives an investor the right to buy or sell the underlying instrument at a specified price while the contract is running. Investors can choose not to exercise their options.

Options are derivative instruments. Unless they exercise an option to purchase shares, option holders do not own the underlying shares or enjoy shareholder rights.

Stock option contracts typically provide the right to buy or sell 100 shares of the stock at the specified strike price on or before the expiration date of the contract, and the price of the option is known as its premium.

Call Options & Put Options:

Only two choices exist: Call options and Put options. A call option gives the holder the right to buy a stock at the strike price before the expiration date of the contract. A put option gives the holder the right to sell a stock at a specified price at the expiration date.

Futures:

A futures contract is a commitment to buy or sell an asset at a future date at a price that is agreed upon in advance. Most easily understood in terms of commodities such as corn or oil, futures contracts are a true hedge investment. For example, in the event that market prices fall before the crop can be delivered, a farmer may want to lock in an acceptable price for the crop. To protect against a subsequent price increase, the buyer also wants to lock in a price.