If you have started with derivative trading, chances are that you have heard about ‘futures’ and ‘options’ trading. Futures and options, also known as F&O, are traded on major exchanges and allow a trader to carry out a trade by making a partial payment.
As a standardized agreement between the buyer and seller, both derivatives tools offer a decent potential for gains. However, you must know the major differences between both. Before we get into that, let us first understand both concepts.
What Are Futures and Options?
Future trading involves trading an underlying asset at a specific price on a specific date in the future. There is a mutual obligation between the buyer and the seller to honor the contract on that date.
On the other hand, options trading allows the trading of an underlying asset at a specific price on a pre-decided date. The buyer has the right but no obligation to purchase the underlying asset before the contract expiry.
Understanding the nature and points of difference between futures and options trading will help you use these trading tools in the best possible way. So, now, let’s get into it.
5 Major Differences Between Futures Trading & Options Trading
While futures and options, both are derivatives, there are major differences between them as listed below.
- Trading Basics
If you are trading online, you need an equity futures trading account for trading futures in the equity segment. However, you can start trading options using a normal trading account. Platforms like Dhan offer an efficient and smooth experience of F&O trading.
Once you obtain a future contract, it must be exercised on the specified date and price in the future. On the other hand, the option buyer has the right to execute/withdraw from the contract at any point before expiration. This is one of the differences between both derivatives.
- Margin and Premium
There is no upfront payment involved in a futures contract. However, the buyer must pay the margin and the full amount on the date specified in the contract. Margin is the amount a trader must pay a broker to enter a futures position and keep it open.
With options, a buyer must pay the premium amount upfront to enter a position on the underlying asset. However, this premium is paid to the trader on the opposite end.
- Timing and Obligation
A future contract can be traded between 9:00 AM to 5:00 PM on weekdays barring national holidays and Sundays. On the other hand, options can be traded between 9:00 AM to 3:30 PM on weekdays. However, you can modify your option positions by 4:15 PM.
The trading is off on Saturdays, Sundays and national holidays. Future contract obliges the buyer to execute the contract at a predetermined date. Option buyers have no such obligation.
- Associated Risk
If the price of the underlying asset for future contracts falls, the buyer still has to execute the contract at the decided price and incur the loss. This is one of the risks associated with futures trading.
The buyer of the options contract has an advantage here. In the case of loss, he/she can choose to let the contract expire worthless. The loss is thus limited to the premium paid for the call/put option buyer/seller. However, if the contract gets executed, call/put option seller/buyer, the loss can be unlimited.
- Profit and Loss
Both futures and options involve chances of profit and loss. Future contracts have the potential for unlimited profit but also unlimited loss.
In the case of options, profit and loss depend on position. If you are a call option buyer or put option seller, your loss will be limited to the amount of premium paid, while profit can be potentially unlimited. For the traders on the other side of the trade, the amount of profit may be capped at the premium received while the loss may be unlimited.
You have two choices when trading derivatives – Future trading and Option trading. While they are both similar, there are certain differences that every trader should know. Understanding the concepts as well as the differences between futures and options play an indispensable role in making potentially profitable trading decisions.