Futures and Options Trading: Definition, Types and Differences

But what exactly are they? And how do they work?

Read on as we tell you all about them. We’ll answer all of your questions and even teach you how to get into future and option trading!

Let’s start.

What are Options?

An option is a financial derivative based on a value of an underlying instrument. This instrument may be a stock, index future, or commodity.

Option owners do not hold ownership of the said underlying instrument, but there are contracts that give them the right to buy and sell it.

This contract guarantees them a specific price that is valid within the timeframe of the contract.

What are Futures?

On the other hand, futures allow investors to either buy or sell an asset as well. The only difference is that they get to agree upon a price and a later date to finalize the exchange.

People who commonly invest in futures are those who wish to protect themselves from the impact of price hikes or plummets. Which is why the asset is commonly a commodity.

Types of Options and Futures

To let you know more about what you’re getting into, let’s discuss the futures and options types in the market. This will also help you decide which of the two is best for your investment goals.

There are two types of options. These are the call and put options.

The difference between the two is the price at which the kind of trade will follow.

Call options allow investors to buy a stock or asset at its strike price. The purchase must be made before the contract expires for validity.

The strike price in this kind of option allows them to make a profit through the trading process through an agreement.

And Put options allow contract holders to sell the security at a price that both ends have agreed upon.

Both call and put options have contracts that confirm their validity and follow an expiration date. The said contract is built upon the agreement of both parties. It secures the safety of the underlying security during the time period.

Now, when it comes to futures, there are two as well. Financial and Physical futures.

The differences between these two kinds lie in what category the securities or assets fall into.

Financial futures focus on solely profit-based investment. These may be of stock, currency, index, or interest rate. Which are found to be the most popular of the futures.

On the other hand, Physical futures are investments made for both profit and ownership of a physical item. A couple of examples are commodities, energies, and even metals.

Again, just as we mentioned earlier, these futures are invested in to avoid the impact and take advantage of price hikes and plummets.

For example, physical futures investments may be made by purchasing a specific commodity right before prices rise and selling them with raised prices for an increased profit.

What is Options and Futures Trading

Now let’s talk about how to do future and options trading.

Both futures and options are derivative investments. They allow you to trade underlying assets at predetermined prices, but how exactly?

You’ll understand it better when we discuss what is future and option trading with example.

Since the profits in these investments are generated from price hikes, the trader would bear a loss if the market goes against the expected current.

A great example would be when a trader buys a call option for a security following a bullish pattern and buys a put option when the strikes take effect.

What are the Differences Between Options and Futures?

Although options and futures both fall into derivative investments and have contracts, they still are distinguishable. Knowing the difference between the two will also help you in choosing which is ideal for you.

Perhaps the biggest futures and options difference would be the requirement of trade within the contract.

Contracts for options allow the investor to buy and sell it. However, the trade is not mandatory, which only means that there is no requirement for them to buy and sell at all.

This is what makes options the safer choice. Since investments like these generate their profits from price hikes, you can still back out from trading if you feel like the market will plummet instead.

But future contracts come with an obligation of a trade. In both profit and physical futures.

That’s because the contract consists of an agreement for the investor to purchase the asset and the seller to deliver it. The only dealbreaker here is that the trade happens at an agreed-upon future date.

Remember that the price at which the future trade will follow will be decided early on. And it is based on the predetermined price of both parties.

Who Should Invest in Futures and Options?

Although future and option trading is widely popular, it’s definitely not for everyone.

Some may find future and option trading to be highly profitable, and some may not. In the end, it all depends on your investment goals and length.

Both have risks that come along with their potential, which may be worth it to some but not to all.

Here are a few examples below that will tell future and option trading is for you:

• If you wish to lessen the impact of security price movements by investing in a derivative contract. This allows you to hedge the risks of the said fluctuations on your asset.
• If your investments are generally based on generating income from price fluctuations. A common example would be tracking securities through technical analysis and buying a premium contract when patterns emerge.
• If you take advantage of price differences in the market and profit from its changing conditions.

Not falling into the category of examples may be an indication that these investments are not ideal for you.

However, if you’d like to, you may always give it a try by investing in small shares. The lower the reward, the lower the risk, of course.