The Differences Between Futures and Options

If you are getting deeper into investing, you have probably come across futures and options. Both are types of derivatives, meaning they get their value from something else, like a stock, commodity, or index. But they work very differently.

When you trade options, you purchase the right to make a trade, but are not required to (until the contract’s expiration). You pay a premium upfront. If the market moves in your favor, you can use the option and make a profit. If not, you let it expire and only lose the premium. There are two types of options, calls and puts. A call is like buying equity in that you’re looking for the price to increase, while a put is similar to a short since you’re looking for the price to decrease. Let’s use an example to see how this works in action. Let’s say you buy a call option for a stock at some strike price (a predetermined cost of the call). Within the contract’s timeframe, if the price increases above the strike price, you can sell immediately and make a profit. But if the price stays below the strike price until the contract expires, you only lose the premium.

On the flip side, when you have a put option, you make a profit when the stock price goes below the option’s cost. If not, you still only lose what you paid as the premium.

Futures, however, are contracts where the buyer and seller agree to trade a specific asset at a set price on a particular date. There is no way out once you enter the contract. If the price moves in your favor, you make a profit. If it moves against you, you take the loss. There is no cap on either. Futures require margin, and gains or losses are settled every day. If a buyer and seller agree on an oil contract, for example, and the price increases, the buyer makes a profit while the seller loses money. There’s nothing either can do in between to end or get out of the contract.

Futures often cost less upfront because there is no premium, but they come with greater potential risk. Options typically cost more initially, but your maximum loss is known from the beginning.

There’s more to consider between futures and options, and I would love to go over the details in another post. If you like to see that drop a comment below!

Sources
Investopedia: Futures vs Options
Groww: Difference Between Options and Futures
RJO Futures: Futures vs Option

Wikipedia: Futures Contract, Options