Differences Between Futures & Options

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Options and futures are both commonly used trading tools in the world of investment and finance. Trading either of them is a little more complicated than simply buying stocks which is a form of investment that many people have at least a basic understanding of.

Used correctly, they both offer where are futures and options traded of opportunities for making money. Options and futures are both widely used to benefit from leverage and they are also both useful tools for hedging purposes. However options and futures are actually very different from each other. This can be a very costly mistake, and no one should ever get involved with any kind of financial trading or investment without knowing exactly what they are doing.

On this page we highlight the similarities between options and futures, look at the main difference between the two, and explain why we believe options trading offers many advantages.

It should be made clear that there are certain similarities between options and futures, and it is understandable how even relatively experienced investors can get the two confused. They are both financial contracts that exist between two parties — the buyer and seller of an underlying asset.

They can both be traded on public exchanges, although some of the more complex contracts are only sold over the counter. They are also both leveraged derivatives — although if you know what this means the chances are that you can already recognize the difference between the two. Basically, a derivative is a financial instrument that derives its value primarily from one or more underlying asset. Leverage is a term for any technique that you use to effectively multiply the power of your capital.

For example, if you buy stocks in a company then you physically own a share in that company and the asset you own can go up or down in value. When buying a derivative, you are buying a contract which is valued according to the underlying asset on which it's based and possibly other factors such as the length of the contract.

Leverage is when you effectively multiply the power of the where are futures and options traded you are investing to generate larger returns; this is possible with both options and futures and is the main reason why they are known as leverage derivatives.

The fundamental difference between options and futures is in the obligations of the parties involved. The holder of an options contract has the right to buy the underlying asset at a fixed price, but not the obligation. The writer, or seller, of the contract is obligated to sell the holder the underlying security or buy itif the holder does choose to exercise their option. This obviously puts the holder of a contract at an advantage, because if the underlying security moves against them, they can simply let the contract expire and not incur any losses over and above the original cost.

If the underlying security moves in the right direction for the holder where are futures and options traded therefore against the writerthen the writer must honor their obligation. In a futures contract, both parties are obliged to fulfill the terms of the contract at the point of expiration. This is a very significant difference. Buying a futures contract where are futures and options traded you will be obliged to buy a particular security at a fixed price carries much more risk than buying an options contract where you have the right to buy a particular security at a fixed price, but are not where are futures and options traded to go where are futures and options traded with it if that security fails to move up in value as you expect.

Both parties involved in a futures contract are effectively exposed to unlimited liability. The costs involved are also different. When an options contract is first written, the writer of it sells it to the buyer and receives the where are futures and options traded that the buyer pays. Depending on the terms of the contract, the underlying security involved, and the circumstances of the writer, the writer may have to have a certain amount of margin on hand.

They may also be required to top up that margin if the underlying security moves against them. However, the buyer owns those contracts outright and no further funds will be required from them. With futures, though, as both parties are exposed to losses depending on which way the price of the underlying security moves, they are both required to where are futures and options traded a certain amount of margin on hand.

Price differences on futures are settled daily, and either party could be subject to a margin call if the value of the underlying security has moved against them. This contributes largely to why futures trading is generally considered riskier than options trading.

Below we look at a couple of the advantages trading options has to offer. As mentioned above, when trading futures you are potentially exposed to big losses whichever side of the contract you are on.

If you have the obligation to buy an underlying security at a fixed price and the security moves significantly above that fixed price, then you could lose substantial sums. Conversely, if you have the obligation to sell an underlying security at a fixed price and the security moves significantly below that fixed price then you could experience sizable losses. If you are writing options contracts and taking on an obligation to either buy or sell an underlying security at a fixed price, then you are exposed to similar risks.

However, you can trade options purely by buying contracts and not writing them. This means that you can limit your potential losses on each and every trade you make to the amount of money you invest in buying specific contracts. Whenever you buy options contracts, the worst case scenario is that they expire worthless and you lose your initial investment. Even if you do want to write contracts in addition to buying them, you can easily create spreads to ensure that your losses are always limited.

The potential for limited where are futures and options traded in options trading is a major advantage, particularly for those that are against high risk investments. Another big advantage options trading offers is versatility. There are a number of strategies that you can use to create spreads that enable you to profit from multi-directional price movements. For example, you could create a spread that would result where are futures and options traded profit if the underlying security went down in value a little bit, or if it where are futures and options traded stable, or if it went up in value by any amount.

This would only result in limited losses if the underlying security went down a significant amount. With futures contracts, you can typically only make money from the underlying security moving in the right direction for you. There could be unlimited losses if your investment moves in the wrong direction or if a neutral result occurs.

Section Contents Quick Links. Advantages of Options Over Futures As mentioned above, when trading futures you are potentially exposed to big losses whichever side of the contract you are on. Read Review Visit Broker.

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Futures are contracts to buy or sell an asset at a specific price on a specific date in the future. Options are contracts that give the buyer the option to buy or sell a particular asset at a specific price anytime before a specific future date. Futures are contracts to buy or sell a particular asset or cash equivalent on a specified future date. For example, a company may use a futures contract to lock in the price of a foreign currency it needs to buy at some future date.

Futures are also widely used for speculative trading. The futures contract is legally binding, no matter what the market value of the asset is when the contract matures. Both the buyer and the seller of a futures contract face potentially high losses if the market is not performing in their favour. To find out more about futures, try the ASX's futures online course. An option is a contract between two parties.

The buyer has the right, but not the obligation, to buy or sell an asset, at a set price, on or before a specified future date. The seller of an option keeps the money paid for the option whether or not the buyer exercises their rights. If you buy an option but don't exercise your right to buy or sell the asset by the due date, it expires and becomes worthless. Options can be bought or sold at any time. The market price of an option will reflect the current value of the asset and the time left before the option expires.

Selling an option can be very risky especially if you don't already own the underlying asset. If the market price rises above the 'exercise' price you may be forced to buy at the market price and immediately sell at the lower 'exercise' price, incurring an immediate loss.

Try the ASX's options course if you want to find out more. Binary options are a type of option where you try to predict the short-term movements of a share price, currency, index or commodity. Unlike other options the holder does not have the right to buy or sell the underlying asset. They are relatively new in Australia and are a speculative, high risk product. Futures and options are complex products. Even experienced investors will struggle to understand the risks involved in trading them.

We recommend you do not invest in these products unless you have a written Statement of Advice from an independent, licensed financial planner stating that the product is suitable for you. Seek financial advice if you need further information and assistance about futures and options.

Futures Options Futures Futures are contracts to buy or sell a particular asset or cash equivalent on a specified future date. Options An option is a contract between two parties.

Binary options Binary options are a type of option where you try to predict the short-term movements of a share price, currency, index or commodity. Warning Futures and options are complex products. Quick links Unclaimed money Publications Financial advisers register Financial counselling Payday loans Unlicensed companies list Report a scam How to complain Other languages eNewsletter. Having a baby Buying a mobile Losing your job more life events