Difference between options and futures – Option Trading FAQ

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Options vs. Futures: What’s the Difference?

An options contract gives an investor the right, but not the obligation, to buy (or sell) shares at a specific price at any time, as long as the contract is in effect. By contrast, a futures contract requires a buyer to purchase shares—and a seller to sell them—on a specific future date, unless the holder’s position is closed before the expiration date.

Options and futures are both financial products investors can use to make money or to hedge current investments. Both an option and a future allow an investor to buy an investment at a specific price by a specific date. But the markets for these two products are very different in how they work and how risky they are to the investor.

Key Takeaways

  • Options and futures are similar trading products that provide investors with the chance to make money and hedge current investments.
  • An option gives the buyer the right, but not the obligation, to buy (or sell) an 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.

Options

Options are based on the value of an underlying security such as a stock. As noted above, an options contract gives an investor the opportunity, but not the obligation, to buy or sell the asset at a specific price while the contract is still in effect. Investors don’t have to buy or sell the asset if they decide not to do so.

Options are a derivative form of investment. They may be offers to buy or to sell shares but don’t represent actual ownership of the underlying investments until the agreement is finalized.

Buyers typically pay a premium for options contracts, which reflect 100 shares of the underlying asset. Premiums generally represent the asset’s strike price—the rate to buy or sell it until the contract’s expiration date. This date indicates the day by which the contract must be used.

Types of Options: Call and Put Options

There are only two kinds of options: Call options and put options. A call option is an offer to buy a stock at the strike price before the agreement expires. A put option is an offer to sell a stock at a specific price.

Let’s look at an example of each—first of a call option. An investor opens a call option to buy stock XYZ at a $50 strike price sometime within the next three months. The stock is currently trading at $49. If the stock jumps to $60, the call buyer can exercise the right to buy the stock at $50. That buyer can then immediately sell the stock for $60 for a $10 profit per share.

Other Possibilities

Alternatively, the option buyer can simply sell the call and pocket the profit, since the call option is worth $10 per share. If the option is trading below $50 at the time the contract expires, the option is worthless. The call buyer loses the upfront payment for the option, called the premium.

Meanwhile, if an investor owns a put option to sell XYZ at $100, and XYZ’s price falls to $80 before the option expires, the investor will gain $20 per share, minus the cost of the premium. If the price of XYZ is above $100 at expiration, the option is worthless and the investor loses the premium paid upfront. Either the put buyer or the writer can close out their option position to lock in a profit or loss at any time before its expiration. This is done by buying the option, in the case of the writer, or selling the option, in the case of the buyer. The put buyer may also choose to exercise the right to sell at the strike price.

What’s The Difference Between Options And Futures?

Futures

A futures contract is the obligation to sell or buy an asset at a later date at an agreed-upon price. Futures contracts are a true hedge investment and are most understandable when considered in terms of commodities like corn or oil. For instance, a farmer may want to lock in an acceptable price upfront in case market prices fall before the crop can be delivered. The buyer also wants to lock in a price upfront, too, if prices soar by the time the crop is delivered.

Examples

Let’s demonstrate with an example. Assume two traders agree to a $50 per bushel price on a corn futures contract. If the price of corn moves up to $55, the buyer of the contract makes $5 per barrel. The seller, on the other hand, loses out on a better deal.

The market for futures has expanded greatly beyond oil and corn. Stock futures can be purchased on individual stocks or on an index like the S&P 500. The buyer of a futures contract is not required to pay the full amount of the contract upfront. A percentage of the price called an initial margin is paid.

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For example, an oil futures contract is for 1,000 barrels of oil. An agreement to buy an oil futures contract at $100 represents the equivalent of a $100,000 agreement. The buyer may be required to pay several thousand dollars for the contract and may owe more if that bet on the direction of the market proves to be wrong.

Futures were invented for institutional buyers. These dealers intend to actually take possession of crude oil barrels to sell to refiners or tons of corn to sell to supermarket distributors.

Who Trades Futures?

Futures were invented for institutional buyers. These dealers intend to actually take possession of crude oil barrels to sell to refiners or tons of corn to sell to supermarket distributors. Establishing a price in advance makes the businesses on both sides of the contract less vulnerable to big price swings.

Retail buyers, however, buy and sell futures contracts as a bet on the price direction of the underlying security. They want to profit from changes in the price of futures, up or down. They do not intend to actually take possession of any products.

Key Differences

Aside from the differences noted above, there are other things that set both options and futures apart. Here are some other major differences between these two financial instruments. Despite the opportunities to profit with options, investors should be wary of the risks associated with them.

Options

Because they tend to be fairly complex, options contracts tend to be risky. Both call and put options generally come with the same degree of risk. When an investor buys a stock option, the only financial liability is the cost of the premium at the time the contract is purchased.

However, when a seller opens a put option, that seller is exposed to the maximum liability of the stock’s underlying price. If a put option gives the buyer the right to sell the stock at $50 per share but the stock falls to $10, the person who initiated the contract must agree to purchase the stock for the value of the contract, or $50 per share.

The risk to the buyer of a call option is limited to the premium paid upfront. This premium rises and falls throughout the life of the contract. It is based on a number of factors, including how far the strike price is from the current underlying security’s price as well as how much time remains on the contract. This premium is paid to the investor who opened the put option, also called the option writer.

The Option Writer

The option writer is on the other side of the trade. This investor has unlimited risk. Assume in the example above that the stock goes up to $100. The option writer would be forced to buy the shares at $100 per share in order to sell them to the call buyer for $50 a share. In return for a small premium, the option writer is losing $50 per share.

Either the option buyer or the option writer can close their positions at any time by buying a call option, which brings them back to flat. The profit or loss is the difference between the premium received and the cost to buy back the option or get out of the trade.

Futures

Options may be risky, but futures are riskier for the individual investor. Futures contracts involve maximum liability to both the buyer and the seller. As the underlying stock price moves, either party to the agreement may have to deposit more money into their trading accounts to fulfill a daily obligation. This is because gains on futures positions are automatically marked to market daily, meaning the change in the value of the positions, up or down, is transferred to the futures accounts of the parties at the end of every trading day.

Futures contracts tend to be for large amounts of money. The obligation to sell or buy at a given price makes futures riskier by their nature.

Examples of Options and Futures

Options

To complicate matters, options are bought and sold on futures. But that allows for an illustration of the differences between options and futures. In this example, one options contract for gold on the Chicago Mercantile Exchange (CME) has as its underlying asset one COMEX gold futures contract.

An options investor may purchase a call option for a premium of $2.60 per contract with a strike price of $1,600 expiring in February 2020. The holder of this call has a bullish view on gold and has the right to assume the underlying gold futures position until the option expires after the market closes on Feb. 22, 2020. If the price of gold rises above the strike price of $1,600, the investor will exercise the right to buy the futures contract. Otherwise, the investor will allow the options contract to expire. The maximum loss is the $2.60 premium paid for the contract.

Futures Contract

The investor may instead decide to buy a futures contract on gold. One futures contract has as its underlying asset 100 troy ounces of gold. This means the buyer is obligated to accept 100 troy ounces of gold from the seller on the delivery date specified in the futures contract. Assuming the trader has no interest in actually owning the gold, the contract will be sold before the delivery date or rolled over to a new futures contract.

As the price of gold rises or falls, the amount of gain or loss is credited or debited to the investor’s account at the end of each trading day. If the price of gold in the market falls below the contract price the buyer agreed to, the futures buyer is still obligated to pay the seller the higher contract price on the delivery date.

Difference between options and futures

Q: What is the difference between options and futures?

A: The primary difference lies in the obligation placed on the contract buyers and sellers.

In a futures contract, both participants in the contract are obliged to buy (or sell) the underlying asset at the specified price on settlement day. As a result, both buyers and sellers of futures contracts face the same amount of risk.

On the other hand, the option contract buyer has the right but not the obligation to buy (or sell) the underlying asset. Hence the term “option” and this option comes at a price in the form of a premium (more specifically, the time value of the premium). With this “option”, the option buyer’s risk is limited to the premium paid but his potential profit is unlimited.

Sellers of options take on an additional volatility risk in exchange for the premium. However, their potential profit is then capped while their potential losses has no limit. Hence, this premium can be high if the underlying asset is perceived to be very volatile.

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Difference between options and futures – Option Trading FAQ

Indeed, we are very proud to offer an extensive library of online educational material to assist our clients in reaching their trading goals.

Here is where some of our educational material can be found; Feel free contact us to discuss even more educational resources that we can offer.

Where Can I Find Out Information About The Various Futures Contracts Traded? I Would Like To Know, For Instance The Size Of The Contract And The Minimum Fluctuation Or Tick?

On the CannonTrading.com website, go to the “Education” tab near the top of the main page and select “Futures Contract Specifications”.

What Is The Difference Between Trading Currency Futures And FOREX (Foreign Exchange)?

With currency futures, the price is determined when the contract is signed and the currency pair is exchanged on the delivery date, which is usually sometime in the distant future.

In the FOREX, the price is also determined at the point of trade, but the physical exchange of the currency pair takes place right at the point of trade or within a short period of time thereafter and there is no expiration date or delivery date with FOREX currency pairs.

However, it is important to note that most participants in the futures markets are speculators who usually close out their positions before the date of settlement and, therefore, most contracts do not tend to last until the date of delivery.

Is there any trading platform that offers both currency futures and FOREX (Foreign Exchange)?

Yes, E-Futures international trading platform offers both currency futures and FOREX.

What is there to know about initial margin and day margin?

Initial margin is set by the exchange, day margin is set by the Broker. All Traders need to meet full margin going into the Globex close per market. For example the ES (S&P mini) close is 5:00 pm eastern

Where can I find day trading and initial margin requirements on your website?

You can find day and initial margin requirements for ALL markets here:

If I am a self-directed trader, will I still have access to a broker or a trade desk if I have a problem?

Once you have a live account, you will be provided with contact information for your broker and a trade desk, you will never be have to rely just on email correspondence, particularly if you are trying to manage risk.

I have not traded futures before, which platform should I choose?

Cannon Trading offers 5 different Futures Commission Merchant (FCMs) to choose from, our clients have over twenty different trading platforms to choose from. If you have not traded futures before, one of our most popular trading platforms is the E-Futures International. This platform supports a full range of order types, real time charts, Depth of Market (DOM) and option chain with many different indicators at no cost.

Does Cannon Trading offer platforms with any inactivity fees?

Yes, most of our platforms do not charge inactivity fees. Our FireTip platform, Sierra Charts platform, CQG, Rithmic, CT4, etc. all do not charge inactivity fees. Please contact your broker today to make sure the platform ( Clearing House) you are using does not charge an inactivity fee.

What types of Data Feeds are supported by Cannon Trading?
  • CQG
  • Rithmic
  • Gain Capital (OEC)
  • iQFeed
  • TransAct
  • Patsystems
At Cannon Trading, is it possible to have a self-directed and managed futures account configuration at the same time?

Yes, absolutely; this is a popular account configuration with many of our traders/clients. Many of our clients consider managed futures/automated trading system(s) to be nice compliments to their self-directed trading.

A professional broker here at Cannon Trading can guide you through the process of setting up a similar main account/sub-account(s) configuration.

In viewing the managed and automated trading systems that Cannon Trading offers, what are the key factors to consider when deciding on which potential programs to add to my portfolio?

Your licensed Cannon Trading professional can discuss with you the potential risks and rewards of adding any particular managed futures/automated program(s) to your portfolio.

Your broker can ascertain your risk appetite and investment goals after consultation with you. In the opinion of many professionals in the futures industry, there are indeed certain key focus points that can potentially carry heavier weight when reviewing/considering futures investment programs and alternative investments in general.

Where are my funds kept and how soon can I get funds sent?

Your funds are deposited into a “segregated” account, in your name, at the bank that your FCM uses. Since the account is segregated, and the funds are not coming led with the FCM’s funds, any excess margin will go out the same day they are requested as long as request received before 12:00PM EST.

LINK to safety of funds booklet?

Can I open an IRA Account to trade futures?

Yes, you can. We Offer several different Custodians and the following types of Individual Retirement Account structures, An Individual IRA, A Roth IRA, A Sep IRA, A Simple IRA, a Rollover 401K, a Solo K Plan, and if you don’t see the structure you are interested in please call one of our professionals at Cannon to identify the account that is best for you.

Who should consider a self-directed IRA?

Anyone who wants to take control of his/her retirement investments, or who is unhappy with their current retirement plan returns, should consider a self-directed account. Most typical IRA custodians (like banks and brokerage firms) only allow you to invest in the products they sell. These include more “traditional” investments such as stocks, bonds, and mutual funds. Non-traditional or alternative investments commonly acquired with self-directed IRAs are not widely known because the majority of IRA custodians do not offer these assets as investment options, so they do not promote them. The IRS permits investments into a wide variety of assets, but each custodian decides which assets it is willing to hold and self-direct their retirement accounts.

Alternative investments permitted within a self-directed IRA include:

  • Real estate
  • Notes and mortgages
  • Partnerships/LLCs
  • Private placements and private stock
  • Single-member LLCs (checkbook IRAs)
  • Futures and foreign exchange (forex) trading
  • Precious metals and more
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