Trades- Comparison Between Option and Future Contracts
While futures and options resemble each other in a number of underlying principles, there is a striking difference between them and they should never be used to replace one another because misunderstandings may occur, that will lead to investors losing their profits.
The dissimilitudes between the contracts will be outlined in the following paragraphs to ensure there will no confusion between futures and options. Consequently, potential investors will know which to choose in order to pruchase or sell rights to access stocks or commodities.
Options Contract – Definition
An option represents a contract entitling the investor with the right to buying or selling stock or commodities existing in the market. The option is not a stock in itself, but the right to sell or buy stock, according to necessities. The options contract stipulates certain conditions, an expiration date for the option and the price of it, which will remain fixed.
Futures Contract – Definition
A futures represents a contract that obliges the trader to deliver a certain stock, commodity or currency if required. Similar to the options contract, the futures contract stipulates an expiration date and the price of the future, which is fixed, so that futures which are past their expiration dates become undesirable.
It is equally important to note that the the stockholder is required to abide by the conditions and deliver the stock, regardless of whether he wants it or not, while the stockholder in an options contract has the freedom to decide whether delivering the stock or not would be lucrative for his purposes.
Options Versus Futures
Differences include, apart from investor obligations and rights, how are stocks and commodities traded, how gains are produced and also how commissions are calculated.
While in futures contracts, investors are free to agree to the contract without having to pay an initial, starting fee, in the options contracts, investors are required to pay a bonus to those holding the contracts. Investors can then possess the right to the stock options; bear in mind that the strategy of paying a bonus occurs because the investor is then granted the liberty to either access his rights to the option or not, that it to sell or buy the stocks if the market is favorable or if the market is unfavorable to reject any future transactions.
The size of traded positions also differs. In futures, trades are generally larger compared to those belonging to options. Since the amount of traded stocks is so large, risks also increase because the investors risk losing more than they bargained for if dealing with futures contracts so this would be a reason why options are safer, since the traded quantities are generally smaller.
Also, gains are earned differently in the two contracts. Options give the possibility to gain profits through three ways. The holder can make use of his rights in the stocks, purchase additional options or remain in expectation till the expiration date closes in so that he or she can garner the difference between asset and fixed prices. In this case, profits would be made from this difference. In future contracts, investors can earn more by purchasing opposite position or by trading daily and as fast as possible available positions.
It is vital to correctly identify the differences between the two since this can prevent you from getting involved in trades that will lead to unnecessary losses.
Bear in mind that you should trade only when you have carefully researched the market and feel confident enough that you won't make any wrong decisions. It is thus best to test the waters before plunging into its depths.
