Options And Futures Trading

What is the difference between Options and Futures trading?

The main fundamental difference between options and futures lies in the obligations they put on their buyers and sellers. An option gives the buyer the right, but not the obligation to buy (or sell) a certain asset at a specific price at any time during the life of the contract. A futures contract gives the buyer the obligation to purchase a specific asset, and the seller to sell and deliver that asset at a specific future date, unless the holder's position is closed prior to expiration.

Futures may be great for index and commodities trading, but options are the preferred securities for equities.

Aside from commissions, an investor can enter into a futures contract with no upfront cost whereas buying an options position does require the payment of a premium. Compared to the absence of upfront costs of futures, the option premium can be seen as the fee paid for the privilege of not being obligated to buy the underlying in the event of an adverse shift in prices. The premium is the maximum that a purchaser of an option can lose.

Another key difference between options and futures is the size of the underlying position. Generally, the underlying position is much larger for futures contracts, and the obligation to buy or sell this certain amount at a given price makes futures more risky for the inexperienced investor.

The final major difference between these two financial instruments is the way the gains are received by the parties. The gain on a option can be realized in the following three ways: exercising the option when it is deep in the money, going to the market and taking the opposite position, or waiting until expiry and collecting the difference between the asset price and the strike price. In contrast, gains on futures positions are automatically 'marked to market' daily, meaning the change in the value of the positions is attributed to the futures accounts of the parties at the end of every trading day - but a futures contract holder can realize gains also by going to the market and taking the opposite position.

Forward Contracts and Call Options

Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets at specified prices on future dates. Forward contracts and call options can be used to hedge assets or speculate on the future prices of assets.

Explaining the Differences between Forward Contracts and Call Options

A call option gives the buy or holder the right, but not the obligation, to buy an asset at a predetermined price on or before a predetermined date, in the case of an American call option. The seller or writer of the call option is obligated to sell shares to the buyer if the buyer exercises his option or if the option expires in the money.

Does the seller (the writer) of an option determine the details of the option contract?

The quick answer is yes and no. It all depends on where the option is traded. An option contract is an agreement between the buyer and the seller of the contract to buy or sell an underlying asset at a certain price, amount and time. These are referred to as the strike price, the contract size and the expiration date, respectively. Options are sold in two places: on option exchanges and over the counter.

Option Exchanges

Option exchanges are similar to stock exchanges in that trade happens through a regulated organization, such as the Chicago Board Option Exchange (CBOE). Exchange-traded options at the basic level are standardized; this means that each option has a set standard underlying asset, quantity per contract, price scale and expiration date.

Flexible exchange options

options (FLEX) allow for customization of the contract specifics of exchange-traded options; they are most often written by a clearing house. There are also exchange-specified rules that must be followed when creating a FLEX option;