Options trading and futures trading are two common ways to invest in the financial markets. While there are substantial distinctions between the two, each of these investment vehicles give traders the chance to earn by betting on the changes in asset prices. We will examine five little-known distinctions between trading in futures and options in this article. The five differences between futures and options trading are based on the following grounds.
- Contract Specifications
- Margin Requirements
- Settlement Process
- Price Movements
- Trading Hours
We shall analyse the differences minutely on these 5 parameters. However, lets’ begin with discussing the basics of futures and options trading.
What Are Futures?
Futures contracts enable traders to purchase or sell an underlying asset at a fixed price and future date. Traders use futures contracts to control their exposure to changes in the price of the underlying asset. They may also speculate on the asset’s future price. Gold, oil, or wheat and even equities or bonds, are usually the underlying assets.The supply and demand for the underlying asset influence the price of futures contracts, which are exchanged on exchanges.
What Are Options ?
Options contracts are a sort of financial instrument that provide the buyer the option—but not the obligation—to purchase or sell the underlying asset at a fixed price and future date. Options contracts don’t demand that the buyer accept ownership of the underlying asset, in contrast to futures contracts. Instead, depending on the state of the market at the moment, options contracts provide the buyer the freedom to decide if they want to exercise their option.
The contract details between futures and options are one of the key distinctions. The underlying asset, contract size, delivery date, and location are all standardised details of futures contracts. As an illustration, the typical gold futures contract on the COMEX exchange calls for the delivery of 100 troy ounces of gold in New York City.
The sum of money that traders must deposit with their brokers in order to open and keep open trading positions is known as margin. The margin requirements for futures and options are varied. Futures traders must deposit an initial margin, which is a portion of the total contract value, in order to establish a trading position. Also, in order to prevent a margin call, which necessitates the deposit of extra funds, traders must maintain a minimum margin level during the duration of the contract.
On the other side, option traders must pay a premium to purchase or sell an options contract. The premium is the most money a trader can lose in a losing trade. In contrast to the margin demands in futures trading, the premium is not refundable and is paid in advance.
Another distinction between futures and options trading is the settlement procedure. The settlement procedure for futures contracts is simple: on the delivery date, the trader must either accept delivery of the underlying asset or settle in cash.
For options contracts here’s how the settlement method works.
- Options contracts can be settled in cash or in physical form.
- In a cash settlement, the trader is given a cash payment depending on the discrepancy between the strike price and the underlying asset’s market price at the expiration date.
Settlement Method for Options contracts.
- The price of an option fluctuates in response to changes in the value of the underlying asset as well as other elements like volatility and time to expiration.
- Options traders can make money in both rising and declining markets, but their approaches will vary. For instance, when the market increases, a call option will profit, and a put option will profit when the market decreases.
The trading hours for futures and options trading are different. The exchange where the contract is exchanged sets the hours for futures trading. For instance, the CME Group’s E-mini S&P 500 futures contract trades from 4:00 p.m. to 5:00 p.m. Central Time on Sunday through Friday (CT).
There are important distinctions between futures and options trading that traders need to be aware of before trading. Let’s summarise them.
- The differences include the terms of the contract, the margin needs, the settlement procedure, price changes, and trading hours.
- Trading professionals can reduce their risk and make wise investment judgements by clearly understanding these variances.
- Before engaging in futures or options trading, traders must have a firm grasp of the market, the asset they wish to trade, and their trading goals.
It is important to remember that dealing in futures and options carries significant risks and may not be suitable for all investors. To minimise their losses, traders should always do extensive study, comprehend market dynamics and trends, and apply risk management techniques. Also, you should trade with reputed brokerage firms like Kotak Securities having reasonable charges. They also offer one of the best demat apps and trading apps. You can easily open your brokerage accounts and start trading in any market segment of your choice.
Should you trade futures vs options?