Futures and options can both be used to speculate on the price movements or hedge existing investments.
Both futures and options are derivative securities, meaning their value is derived from an underlying asset, such as a stock or commodity.
Futures require the contract holder to buy or sell an asset on a specific date, while options give the choice, not the obligation, to do so.
Both futures and options can be risky, but the risk to the individual investor can be greater for futures because of the obligation to sell.
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Futures and options are two types of derivative securities. This means that neither options nor futures have inherent value. Instead, they derive their value from an underlying asset, such as a commodity, currency, or stock market index. Both are financial contracts that set the terms of a transaction to take place at a future date.
Options, as the name implies, give a buyer the option, but not the obligation, to go through with the transaction. Futures, on the other hand, require that the agreed-upon transaction takes place when the contract expires.
What are futures?
Futures contracts are arrangements in which a buyer agrees to purchase an underlying asset, most often a commodity, for a set price on a specified future date. For instance, a futures contract buyer may agree to buy 100 barrels of oil in the future for a specified price, and the contract seller must make good on those terms.
Futures contracts began as a way for farmers to lock in prices for their harvests to protect themselves against bad weather, insects, and anything that may threaten their crops. Since those early days, futures have evolved, and now their underlying assets may be other types, such as US Treasuries. There are also futures contracts tied to equity indexes like the S&P 500.
Futures contracts can be purchased on margin, which means traders only have to maintain a fraction of what they are trading in their account. Typically, the requirement is 3%-12%, so a futures trader could invest $100,000 with as little as $3,000 of their own cash. This stands to greatly magnify gains — as well as losses.
Investing in futures is considered highly risky due to their low margin requirements and guarantee of closing. Hence, this type of trading is usually left to professional investors.
What are options?
In the US, options contracts give buyers the right to buy (in the case of a call option) or sell (in the case of a put option) an underlying asset for a set price, known as the strike price, on or before a specific date in the future. The key difference here is that options don’t obligate the buyer of the contract to go through with the transaction. If they don’t exercise the option, they lose the premium, or the amount they paid to purchase the contract.
Like futures, options are most often bought and sold among institutional investors, who tend to use them as part of complex trading …read more
Source:: Business Insider