what is options and futures
Options and futures are two
types of financial derivatives that allow investors to hedge risk or speculate
on future price movements. Both options and futures contracts are agreements
between two parties to buy or sell an underlying asset at a predetermined price
and time in the future.
What
are Futures?
Futures are contracts that
obligate the buyer to purchase an asset or the seller to sell an asset at a
predetermined price and time in the future. Futures contracts are standardized,
which means that the terms of the contract, such as the size of the contract,
the expiration date, and the delivery date, are the same for all parties.
Futures contracts are traded
on exchanges, such as the Chicago Mercantile Exchange (CME), where buyers and
sellers can enter into contracts with each other. Futures contracts are used by
investors to hedge against price fluctuations in the underlying asset. For
example, a farmer may use a futures contract to lock in a price for a crop that
will be harvested in the future.
What
are Options?
Options are contracts that
give the buyer the right, but not the obligation, to buy or sell an underlying
asset at a predetermined price and time in the future. Options contracts are
also standardized, but they provide more flexibility than futures contracts.
There are two types of options: call options and put options.
Call options give the buyer
the right to buy an underlying asset at a predetermined price, while put
options give the buyer the right to sell an underlying asset at a predetermined
price. Options contracts are traded on exchanges, such as the Chicago Board
Options Exchange (CBOE), where buyers and sellers can enter into contracts with
each other.
Options contracts are used by investors to hedge against price fluctuations in the underlying asset or to speculate on future price movements. For example, an investor may buy a call option on a stock if they believe the stock's price will increase in the future. If the stock's price does increase, the investor can exercise the option and buy the stock at the predetermined price.
difference between options and futures
One of the main differences
between futures and options is the degree of obligation that comes with each
contract. Futures contracts are binding agreements that require both the buyer
and the seller to complete the transaction at a predetermined price and date in
the future. This means that once the futures contract is entered into, both
parties are obligated to fulfill the terms of the contract, regardless of how
the price of the underlying asset changes. On the other hand, options contracts
give the buyer the right, but not the obligation, to buy or sell the underlying
asset at a specific price and time in the future.
Another significant difference
between futures and options is the degree of flexibility that each instrument
offers. Options contracts can be tailored to suit specific investment
strategies, with the buyer able to choose the strike price and expiration date
that best suits their needs. In contrast, futures contracts are standardized,
meaning that all contracts for a particular underlying asset have the same
expiration date and contract size. While this makes futures contracts simpler
to trade, it also limits their flexibility and customization options.
Margin requirements are also
another key difference between futures and options. Options contracts typically
require lower margin requirements than futures contracts, as the buyer only
needs to put up enough collateral to cover the premium paid for the option. In
contrast, futures contracts require higher margin requirements, as the buyer is
obligated to fulfill the terms of the contract, which could result in a large
financial obligation if the price of the underlying asset moves significantly
against the buyer.
Finally, the nature of the
settlement for each contract is different. Futures contracts usually settle in
cash, with the gains or losses calculated based on the difference between the
contract price and the current market price of the underlying asset. In
contrast, options contracts can be settled either in cash or by delivery of the
underlying asset itself.