Difference between Futures & Options

While both futures and options are contracts between two parties to exchange stocks at a fixed price on a future date, there are some differences between the two.

While both futures and options are contracts between two parties to exchange a predefined number of stocks at a fixed price on a future date, there are some differences that set the two apart. Let us understand what these differences are.

Obligation

The first and the most important difference between futures and an option contracts the obligation they put on both the parties involved in the contract. In a futures contract, the buyer and the seller have to exercise the trade on or before the specified date. However, in options, the buyer has the right, but is not obliged to carry out the transaction. In case the buyer decides to exercise the option, the seller has to sell his holdings.

Upfront cost

Apart from the obligations, upfront cost is another differentiation. Traders can participate in a futures contract without paying any upfront cost. However, buying an option involves paying a premium. This premium is a kind of fee paid by the buyer for waiver of the obligation to exercise the trade.

Liability

There is one huge difference in Futures and Options trading, one that affects the potential profits and losses incurred by traders. The buyer's liability, in case of a futures contract, becomes unlimited if the prices start moving in the opposite direction. However, in stock options, the buyer's liability is limited only up to the money invested in buying the options. Only the writers of options are exposed to unlimited liability.

Expiration

When a futures contract expires, the buyer has to buy the specified number of stocks mentioned in the contract. On the other hand, if the options are out of the money, the buyer can let the contract expire and become worthless.

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