What is the Difference Between Futures & Options

In the stock market, Futures and Options are popular trading instruments that allow you to make profits by predicting price changes. Both are called derivatives, which means their value is based on something else, like the price of a stock, index, or commodity.

While they sound similar, Futures and Options work in different ways and have different risks and rewards. This guide will help you understand both with simple examples and explain the key differences in liquidity, value, capital, and who should trade them. Let’s break it down in easy terms!

Open Demat account -  Start investing with a quick setup

Understanding Options and Futures

What Are Futures?

A Futures contract is an agreement to buy or sell an asset (like stocksor commodities) at a future date for a set price. The buyer is obligated to buy, and the seller is obligated to sell, at that price, regardless of the market price on the contract’s expiry date.

Example:

Imagine you believe that the price of oil will go up. You enter into a Futures contract to buy oil at ₹3,000 per barrel for delivery in one month. If the price rises to ₹3,500, you make a profit. If it falls to ₹2,500, you face a loss.

What Are Options?

An Options contract gives the right, but not the obligation, to buy or sell an asset at a set price within a specific time. There are two types of Options: Call and Put. The buyer pays a premium for this right.

Example:
You buy a Call Option for stock XYZ at ₹500 for one month. You pay a ₹30 premium for the right to buy stock XYZ at ₹500. If the stock price goes up to ₹600, you can buy at ₹500, sell at ₹600, and make a profit. But if the stock price stays below ₹500, you lose the ₹30 premium paid.

Types of Options: Call and Put Options

There are two types of options:

1) Call Options:

A Call Option gives the right to buy an asset at a certain price (called the strike price) before a set time.

• Example: You buy a Call Option for ₹100 on stock ABC, with a strike price of ₹1,200. If the stock price rises to ₹1,500, you can exercise the option to buy at ₹1,200, making a profit of ₹300 minus the premium paid.
• Who buys Call Options? Investors who expect prices to rise.

2) Put Options:

A Put Option gives the right to sell an asset at a certain price before a set time.

• Example: You buy a Put Option for ₹50 on stock XYZ, with a strike price of ₹1,500. If the stock falls to ₹1,200, you can sell at ₹1,500, making a profit of ₹300 minus the premium paid.
• Who buys Put Options? Investors who expect prices to fall.

Key difference: Call options are bought when expecting the price to rise, while Put options are bought when expecting the price to fall.

Options vs Futures - Which is Better?

Aspect

Futures

Options

Obligation

The buyer and seller are obligated to buy or sell at the agreed price.

The buyer has a right but no obligation to exercise the option.

Risk

Risk is unlimited as both buyers and sellers can face large losses if prices move significantly against them.

Limited to the premium paid for the option. Losses are capped at the premium.

Profit Potential

Can be unlimited for the buyer if the price moves in their favor.

Profit is limited by the price movement but can be significant, especially for call options.

Expiry

Futures contracts have a fixed expiry date after which the contract settles.

Options have a fixed expiry too, but they are not exercised unless it’s profitable.

Complexity

Futures are more complex and require understanding of margin calls and the obligations of the contract.

Options are simpler but still need a good understanding of strike price and expiry.

Use

Futures are often used for hedging or speculation in commodities, currencies, and financial assets.

Options are commonly used for hedging or to leverage small movements in prices.

Liquidity

Futures markets are generally more liquid, with higher trading volumes.

Options markets may have less liquidity, and spreads can be higher for less popular options.

Capital Required

Requires a margin deposit which can vary with the contract size and volatility.

Requires the premium to be paid upfront, but you do not need to pay the full value of the contract.

Which is better?

• For beginners, Options may be easier to understand due to limited risk (premium only).
• For active traders who want to manage large positions and higher risk, Futures may be a better choice.

What is the Difference Between Options and Futures Based on Liquidity?

Liquidity refers to how easily an asset can be bought or sold in the market without affecting its price.

• Futures: Futures contracts generally have better liquidity. Since they are used by large institutional traders, there are more buyers and sellers, and you can enter or exit a trade quickly. The futures market often has more participants, which results in narrower bid-ask spreads.
• Options: Options, while liquid, can sometimes face lower liquidity for less popular contracts, especially out-of-the-money options. If a particular option is not widely traded, it can be hard to find a buyer, leading to higher spreads and less favorable pricing.

Futures and Options Difference Based on Value

• Futures Value: The value of a Futures contract is based on the underlying asset’s price and the contract size. There is no time decay, so the contract value increases or decreases as the market price of the underlying asset moves.
• Options Value: The value of an Options contract depends on:
• Intrinsic value (how much the option is in the money).
• Time value (how much time is left before expiry).
• Volatility (how much the underlying asset’s price is expected to move).
• Premium (the cost of buying the option).

The value of an Option can change due to market conditions and time decay, even if the underlying asset's price doesn't change much.

Options vs Futures Difference Based on Capital

• Futures Capital: Futures trading requires margin. This is a small percentage of the total contract value, but it can lead to large gains or losses because of leverage. You need to have enough capital to maintain your margin, and if the price moves against you, you may get a margin call to add more money.
• Options Capital: In options trading, you pay an upfront premium for the option. This is the maximum amount you can lose. Because the premium is much lower than the full value of the contract, options allow you to control a larger amount of the underlying asset with a smaller capital outlay. This can lead to higher returns on investment (ROI), but your risk is limited to the premium paid.

Who Should Invest in F&O Trading?

Futures and Options (F&O) trading is not for everyone because it involves higher risks and requires a good understanding of market behavior.

• For Experienced Traders: F&O can be ideal for experienced traders who understand the risks of leverage and are familiar with hedging strategies.
• For Speculators: Those who want to profit from price movements but don’t want to own the asset (like a stock) may find F&O trading attractive.
• For Hedgers: Businesses or investors who want to protect themselves from price swings in assets (like commodities) can use futures or options for hedging.
• For Beginners: F&O is not recommended for beginners because of the complexity and risk of losing more than your initial investment (especially in Futures).

Before starting, ensure you understand the risks, have sufficient capital, and practice on paper trading or small positions. Always use risk management like stop-loss orders to control potential losses.

Conclusion

Futures and Options are powerful tools for trading and speculation, but they require an understanding of risk and market behavior. Futures involve the obligation to buy or sell at a specific price, while Options give the right to do so without obligation. Both have their uses and can help you manage risk or profit from price movements. However, they also come with significant risks and are not suited for everyone. Beginners should start small, learn the basics, and use these tools with caution.