Difference Between Options and Futures

Trading isn’t just about taking advantage of price fluctuations by buying or selling shares. Especially when you deal with commodities or indices, you’ll come across two key instruments, known as futures and options. 

At first glance, these two might look the same. But in nature and in how their value changes, they are quite different. So, now the question is, what is the difference between futures and options?

In this blog, we will discuss the difference between futures and options and their features.

Understanding Options and Its Features

Options are derivative contracts and these give you the right, but not the obligation, to buy or sell an asset at a specific price. This asset can be stocks, commodities, or indices. You can buy or sell it at a fixed price called the strike price. You have to use this right within a certain time period. To obtain this right, you pay a fee called the premium.

There are two types of options, which are:

• Call Option: It gives you the right, but not the obligation, to buy the asset at a fixed price. Say, you buy a call option with a ₹100 strike price. Now the stock rises to ₹120. Here, you can exercise your call option to buy at ₹100 and make a profit.
• Put Option: It gives you the right, but not the obligation, to sell an asset at a fixed price. For example, if you buy a put option with a ₹100 strike price. Now, the stock falls to ₹80,you can exercise your put option to sell at ₹100 and make a profit.

Features of Options

Some of the features of options are listed below:

1. Right Without Obligation

Options give the buyer the right to buy or sell the underlying asset. Remember, it is not the obligation to buy or sell the underlying asset at a fixed price within a set timeframe.

2. Premium-Based Contract

The buyer pays a premium to the seller (writer) for this right. Premium is the maximum loss for the buyer. For the seller, it is the maximum profit if the option expires worthless, but risk can be much higher.

3. Defined Risk and Unlimited Reward (for Buyer)

Buyers can only lose the premium, but their potential gain is theoretically unlimited (in the case of calls) or substantial (in puts).

4. Obligation on Seller

The seller must honor the contract if the buyer chooses to exercise the option. This exposes the seller to significant risk, especially in uncovered positions.

5. Contract Size (Lot Size)

Options are traded in fixed lot sizes, which vary depending on the underlying asset (e.g., 25 shares for some stock options in India). This determines the total premium of the contract.

6. Strike Price

This is the pre-decided price at which the option buyer can exercise the option. It directly impacts profitability and intrinsic value.

7. Intrinsic and Time Value

An option’s price (premium) consists of:

• Intrinsic Value: The real, in-the-money value.
• Time Value: The extra value due to time left until expiry and expected volatility.

8. Expiry Date

Every option has a specific expiry date, post which it becomes invalid. This could be weekly, monthly, etc.

9. American vs. European Options

• American Options: Can be exercised any time before expiry.
• European Options: Can only be exercised on the expiry date (common in India for index options).

10. Used for Hedging and Speculation

Options serve multiple purposes such as:

• Hedging: Options can be used to protect an existing portfolio.
• Speculation: Options can be used to bet on directional movement.

Read Also: What is Options Trading?

Understanding Futures and Its Features

A futures contract is a standardized derivative contract, which defines terms for buying or selling an asset at a predetermined price on a specific date in the future. The underlying asset can be a commodity, currency, stock, or index.

Unlike options, futures come with a clear obligation. Both the buyer and the seller must honour the contract, no matter what the market price is at the time of expiry. So, whether the price goes up or down, the contract has to be honored.

The best example of this is a farmer who agrees to sell wheat at ₹2,000 per quintal after 3 months. Even if market prices change, both buyer and seller must honor the deal. It ensures price certainty but involves risk as the price of the underlying asset may move against your position. These are traded on organized exchanges, ensuring transparency and easy access. 

Features of Futures

1. Standardization

Futures contracts are standardized contracts with terms such as the quantity, quality, and delivery date of the underlying asset pre-determined. 

2. Exchange-Traded

All futures contracts are traded on regulated exchanges. This ensures transparency. Also, since the futures contracts are accessible to all, there is more liquidity.

3. Obligation to Buy/Sell

Both the buyer and the seller must fulfill their obligation based on the futures contract specifications. The futures contract can either be settled through physical delivery of underlying assets or via cash settlement. 

4. Margin Requirements

Traders must deposit an initial margin. It is important to maintain a minimum balance (maintenance margin) as collateral to hold on to your trading positions. 

5. Leverage

Futures contracts allow traders to make a relatively large trading position with a small amount of money, known as margin. This helps increase potential profits, but also magnifies losses.

6. Mark-to-Market Settlement

Profits and losses are settled daily. The value of your trading position is adjusted at the end of every trading day to reflect the current market price.

7. Hedging and Speculation

Futures can be used by hedgers to protect their investment portfolios against adverse price fluctuations. Futures contracts can also be used by speculators to profit from price movements.

8. Expiration Date

Every futures contract has a set expiration date. This is the date on which the contract must be settled, either by delivery of underlying assets or by cash.

9. Settlement Options

Contracts can be settled by physical delivery of the asset or by cash settlement. It is based on the contract specifications.

10. Liquidity and Price Transparency

Futures markets are highly liquid and are traded on the exchanges. This ensures efficient price discovery and easy entry/exit for traders.

Read Also: What is Future Trading and How Does It Work?

Difference Between Futures and Options

Now that you know the basic details of both, let us explore the difference between futures and options here:

Feature	Futures Contracts	Options Contracts
Obligation	Buyer and seller are obliged to complete the transaction on the agreed date.	Buyer has the right, not the obligation, to buy/sell the asset before expiry.
Execution	Must be executed on the specified future date.	Some options can be exercised anytime before expiry (for American options).
Upfront Cost	No upfront premium; margin is required.	The buyer pays a premium upfront to buy the option.
Risk	Higher risk; both parties can face unlimited profit or loss.	Limited risk for buyers (loss limited to premium paid).
Profit/Loss Potential	Both profit and loss potential can be large and theoretically unlimited depending on price movements.	Profit can be unlimited; loss for buyers is limited to premium.
Liquidity	Generally higher liquidity; suitable for day trading.	Far OTM and ITM options may be less liquid compared to futures.

Read Also: Best Options Trading Chart Patterns

Key Differences Between Futures and Options You Should Know

Till now, you know what the difference is between futures and options at large. But do you need to focus on all while investing? Well, yes, but there are some that hold more importance. These are:

1. Liquidity

Futures are generally more liquid than options.

At a given time, there can be only three to four futures contracts with different expiries available for trading, due to which they have higher volumes. On the other hand, there can be dozens of options contracts of the same asset with different strike prices, This makes futures more suitable for intraday traders who need fast execution and minimal price slippage. 

2. Price Movement

Prices of Futures contracts move more quickly compared to options contracts.

Futures contracts mirror real-time price changes in the underlying asset. On the other hand, options react more slowly because their price sensitivity (delta) is usually less than 1. This is because multiple factors, such as time value, delta, and volatility influence them. Out-of-the-money options, in particular, tend to show smaller price changes.

3. Capital Risk and Time Decay

Options, when compared to futures, lose value over time due to time decay.

With options, the premium you pay reduces as the expiry date nears. This is called time decay. That means even if the market moves in your favor, your option might lose value daily. Futures don’t suffer from time decay but carry higher risk due to compulsory execution.

Read Also: Types of Futures and Futures Traders

Conclusion

Understanding the difference between futures and options is key to becoming a smart trader. While both are derivative contracts, they serve different needs. Futures come with an obligation to buy or sell and are preferred for their liquidity. Options, on the other hand, provide an opportunity to speculate with limited risk.

So, what is the difference between futures and options in simple terms? Futures require compulsory execution, while options give you the right but not the obligation. That’s the core of it. Remember, the choice between futures and options is all about risk management and your trading strategy.

To make your trading journey smoother, platforms like Pocketful offer the right technical tools to analyze market movements. So, open a trading and demat account today and start your trading journey.

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