Uncertainty, losses, and gains are a major part of the world of stock markets. However, sometimes due to tons of experience, people become right in predicting the future prices of certain financial securities.
Then they enter into a contract that lets them generate profit. Two of the widely used contracts that allow investors to buy and sell securities at a price that has already been decided are Futures and Options.
I/C
Key Differences
Futures
- It refers to a contract that allows buyers and sellers to buy and sell certain financial securities at a price that has already been decided or at a price that exists today on a particular day, as stated in the contract.
- One of the key features of this contract is that it is mandatory to fulfill the contract as stated by both parties.
- Suppose the buyer and seller entered this contract whereby the prices of certain security will increase according to the buyer. According to the seller, the prices of the concerned security will decrease, but if the prices increase, the seller has no choice but to sell the security to the buyer at a lower price, as stated in the contract.
- If the roles are reversed, meaning if the prices of the concerned security fall or decrease, then it is mandatory for the buyer to buy the concerned security from the concerned seller at a price higher than usual, as stated in the contract.
Options
- It refers to a contract that gives investors the right or choice to buy and sell certain financial securities at a price already decided in advance or at a price that exists today within a particular time frame.
- One of the hallmark features of this contract is that it is not mandatory to fulfill the concerned contract.
- If the buyer and seller have come into this contract where the buyer is predicting that the prices of certain securities will increase in the upcoming future, and the seller is predicting that the prices of the concerned securities will decrease in the upcoming future. Still, in real life, if the prices of the concerned security increase, the concerned seller must sell the required securities at a price already decided as per their contract.
- However, if the roles are reversed, meaning instead of an increase in the price, the prices fall in real life, then it is NOT mandatory for the buyer to buy the concerned securities at a lower price.
Comparison Between Futures And Options
| Parameter | Futures | Options |
|---|---|---|
| Meaning | It refers to a contract that obliges buyers and sellers to buy and sell various financial securities at an agreed price on a particular day per the agreement. It should be noted that these contracts come into work when the actual prices of the concerned securities fall or rise. | It refers to a contract giving buyers and sellers a right or a choice to buy and sell various financial securities at an agreed price or at a price that exists today within a specific time window. Just like Futures, these contracts come into force when there is an actual change in the prices of the securities. |
| Working | When buyers are sure that the prices of certain securities will rise, and sellers are sure that the prices of that very securities will fall, they come into a Futures contract. If the prices of the same securities rise, the sellers have to sell them at an agreed price. However, buyers must buy at an agreed price if actual prices fall. | When buyers are sure that some securities’ prices will rise, they participate in an Options contract. If prices increase, they get to buy those securities at an agreed price, usually a lower price. However, if there is a decrease in the prices, it is completely the buyers’ choice whether to buy or not. The same goes for buyers who want to sell some securities. |
| Mandatory | One of these contracts’ major drawbacks and classic features is that they are mandatory. It does not matter what the parties are incurring, whether losses or profits; they are obliged to make the contract happen as per the agreement. | One of the major advantages of these contracts is that these are mandatory to perform, but rather a choice. If the parties are incurring losses or are not interested anymore, they are not obliged to make the contract happen. |
| Represents | These contracts represent an investor’s obligation to buy or sell financial securities. | These contracts represent an investor’s right or choice to buy or sell financial securities. |
| Types | There are not any types of Futures contracts. | It can broadly be categorized into Call Options and Put Options. |
| Fee | No fee is associated with these contracts. | To invest or indulge in these contracts, generally, a small fee in the form of a premium is required. |
| Time | One of the hallmark features of these contracts is that the buying and selling of securities associated with these types of contracts must take place on a particular day as agreed by both parties. | One of the classic features of these contracts is that the buying and selling of securities concerned with these contracts have to take place within a time frame. Else it would lead to the expiration of the concerned agreement. |
| Risk | These contracts typically are considered riskier than Options, and this is large because these contracts are mandatory to be fulfilled. | These contracts are typically considered less risky than Futures. This is large because these contracts are not considered mandatory but rather a choice. |
| Profit and loss | These contracts are associated with an unlimited amount of profit and loss. | These contracts are associated with unlimited profit but a limited loss. |
Major Differences Between Futures And Options
What exactly are Futures?
When experienced investors are so sure regarding the upcoming price changes of certain financial securities that are very likely to happen, they enter into a Futures contract. This contract lets those concerned investors buy or sell the securities at a price already decided between the two parties.
It should be noted that the buying and selling of various securities must occur on a particular date as specified by both parties in the contract. Another hallmark feature of this contract is that it is a must for both parties to fulfill the contract.
I/C
Features of Futures
- It refers to a contract allowing investors to buy and sell financial securities at a price that both parties have already decided.
- One of the classic features of these contracts that distinguishes them from Options contracts is that they must be fulfilled. These contracts do not give investors a choice but an obligation.
- Unlike the Options contract, the buying and selling of concerned securities must occur on a particular date as specified by both parties in the contract.
- Since these contracts impose an obligation on both parties; hence, the risk associated with these contracts is very high.
- These contracts are associated with an unlimited amount of profit and loss. This is because both parties must fulfill their obligations even if it results in either profits or losses.
What exactly are the Options?
When people are experienced enough to predict some changes in the upcoming prices of certain securities but are unsure, they enter into Options contracts.
As the name suggests, these contracts give investors a right or a choice to buy and sell certain securities at a price that exists today or at a price already decided by both parties. It should be noted that the buying and selling have to take place within a period before it expires. Unlike Futures contracts, these contracts are not mandatory to be fulfilled.
I/C
Features of Options
- It refers to a contract that gives investors a choice or a right to buy or sell certain financial securities at a price that has already been decided or at a price that exists today.
- To buy this contract, one typically has to pay a small amount of money as a premium.
- One of the hallmark features of these contracts is that they are not mandatory to be fulfilled from the buyer’s end. But they are mandatory for sellers.
- Unlike a Futures contract, the buying and selling of concerned securities must occur within a specific time frame instead of a particular date. If the contract is not carried out within the desired time, it leads to the contract’s expiration.
- Since these contracts are not mandatory to be carried out, the risk involved in these contracts is moderate.
- These contracts have an unlimited profit but limited loss. This is because one can gain several profits if the prices of securities come in favor of the concerned parties. However, if the prices come otherwise, there is only a loss of the premium fee as it is not mandatory to fulfill the contract.
The Contrast Between Futures And Options
Meaning
- Futures – It refers to a contract that allows investors in the form of two parties, i.e., buyer and seller, to buy and sell certain financial securities at a price already decided by both parties on a particular date as stated in the contract.
- Options – It refers to a contract that gives investors a choice or right to buy and sell certain financial securities at a price that has already been decided or at a price that exists today. But it should be noted that it has to be done within a specific time frame as stated in the contract.
Working
- Futures – When investors are completely sure about the changes regarding the prices of certain securities that will take place in the future, they invest in Futures. Under this contract, the buyer and seller settle for a price of the concerned securities as if either there is an increase or decrease in the prices of the concerned securities. If prices increase, the seller must sell the security at the agreed price to the buyer, and if prices decrease, the buyer must buy the security at the agreed price.
- Options – When investors predict a change in the prices of certain securities but are not completely sure, they invest in Options. Under this contract, the buyer and seller can buy or sell the concerned securities at an agreed price, depending on whether the prices increase or decrease. If the prices increase, the buyer can choose to buy the securities at a price that exists today or at a price that has already been decided and vice versa. If he is not willing to, he is not obliged to.
Mandatory
- Futures – One of the most important features of this contract is that it is mandatory to complete or fulfill the contract. It does not matter if either of the parties is incurring loss or profit; they still have to buy or sell the concerned securities even if it is causing them huge losses.
- Options – One of this contract’s major advantages and classic features is that it is not mandatory to fulfill the contract on the buyer’s end. If the buyer is incurring losses or is not interested in buying the securities, he does not need to proceed. But suppose the seller is incurring losses upon the sale of concerning securities. In that case, he is obliged to sell the securities no matter what as long as the buyer is still interested in buying.
Represent
- Futures – These contracts represent the obligation of buyers and sellers to proceed with buying and selling certain securities as stated in the contract.
- Options – These contracts are associated with the representation of a right or a choice of buyers and sellers to buy and sell certain securities as stated by them in the given contract.
Types
- Futures – There are not any types of these contracts.
- Options – It can be broadly categorized into two types: Call and Put Options. Call Option is concerned with letting investors, particularly buyers, buy certain securities at a price that exists today or at a price as agreed by both parties if the future prices of the concerned securities increase. In contrast, the Put Option is associated with letting investors, particularly buyers, sell certain securities at a price today or at a price agreed upon by both parties if the future prices of the concerned securities decrease.
I/C
Types of Options
- Call Option: When investors think that the prices of certain financial instruments will increase in the future, then this Option lets those investors buy the concerned security at the price that exists today or at a price that has already been decided before. Still, it must be done within a specific time frame (after prices rise).
- Put Option: When investors think that the price of certain financial securities is going to decrease in the upcoming future, then this Option allows those investors to sell the concerned securities at the price that exists today or at a price that has already been decided before but within a particular time frame (after as and when prices actually fall).
Fee
- Futures – One of the major advantages of these contracts is that one does not have to pay any fee or premium to get indulged with these contracts.
- Options – One of the classic characteristics of these contracts is that it demands investors to pay a small amount of fee in the form of a premium to get indulged in these contracts.
Time
- Futures – One of the significant features of these contracts that distinguishes them from Options is that the buying and selling of various financial securities associated with these contracts must occur on a specific day as agreed by both parties.
- Options – One of the hallmark features of these contracts that is completely different from a Futures contract is that the buying and selling of financial securities associated with these contracts have to take place within a particular time frame as agreed by both parties. If the buying and selling do not occur within the given time frame, the contract stands expired.
Risk
- Futures – Since this contract is considered mandatory and has to take place even if either of the parties is incurring losses. This contract is considered riskier than Options.
- Options – Since this contract only gives investors a choice to invest, it is not mandatory to fulfill this contract. This contract is considered less risky than Futures.
Profit and loss
- Futures – This contract is associated with unlimited profit and loss. This is because this contract must be carried out regardless of the profit and loss. Thus, the profit and loss associated with this contract can not be defined as limited but rather unlimited, as we do not know how much either of the parties would incur in profit or loss.
- Options – This contract is associated with an unlimited amount of profit but a limited amount of loss. This is because an individual could benefit from this contract in unlimited amounts.
- But when it comes to loss, the only loss associated with this contract is the premium that has to be paid, as the contract is not an obligation, and investors can step back if they are incurring losses. The only amount they would lose is the premium.
I/C
Futures vs. Options: A comparison
| Parameter | Futures | Options |
|---|---|---|
| Mandatory | Yes, mandatory on the part of both buyer and seller. | Mandatory only for sellers. |
| Fee | No | Yes |
| Risk | More | Less |
| Profit and loss | Unlimited profit and loss | Unlimited profit and limited loss |
CONCLUSION
Futures and Options are two types of contracts that allow investors to buy and sell financial securities at an agreed price. Due to many similarities, both contracts are often confused with one another, but despite all the similarities, both are very different.
The major difference between Futures and Options is that the former is mandatory while the latter is rather a choice.
FREQUENTLY ASKED QUESTIONS (FAQs)
Q1. What are the different types of Options contracts?
Options contracts can be broadly categorized into two main types: Call and Put.
Q2. What are the differences between Call and Put options?
The major difference between Call and Put options is that the former lets investors buy securities at an agreed price or at a price that prevails today as and when the actual prices rise. In contrast, the latter lets investors sell securities at an agreed price as and when the actual prices fall.
Q3. Why is there high risk in Futures contracts?
A high risk is associated with these contracts because these contracts are mandatory to be performed. It does not matter how much any party is incurring losses, and it is a must to fulfill these contracts.
Q4. What are the major differences between Futures and Options?
The major difference between Futures and Options is that the former represents an investor’s obligation to buy or sell, while the latter represents an investor’s choice to buy or sell. Another significant difference between the two is that the former is fulfilled on a particular day while the latter has to be fulfilled within a particular time frame.
Q5. How do Futures contracts are associated with unlimited profit and loss?
This is because any of the parties involved with these contracts can incur profits and losses whose degree is uncertain. They can make a little profit/loss or can make a very high profit/loss.
Q6. How do Options contracts are associated with unlimited profit but limited loss?
This is because any party can make profits ranging from low to high. Since these contracts are not mandatory, they can choose to exit if they incur losses. In that case, a party’s only loss would be the premium amount.
Similar Posts:
- 20+ Differences between CFD and Spread Betting (Explained)
- 20+ Differences between Stocks And Options (Explained)
- 20+ Differences between ETF and Mutual Funds (Explained)
- 20+ Differences between Hedge funds And Mutual funds (Explained)
- 20+ Differences between Dividend And Interest (Explained)
Business, marketing, and blogging – these three words describe me the best. I am the founder of Burban Branding and Media, and a self-taught marketer with 10 years of experience. My passion lies in helping startups enhance their business through marketing, HR, leadership, and finance. I am on a mission to assist businesses in achieving their goals.