Difference between Futures and Options

The main difference between futures and options is that options have optionality, while futures don’t.

A futures contract is binding for both sides. When you hold a futures position, you have the right and obligation to buy (with a long futures position) or sell (with a short futures position) the underlying asset at a given price (the futures price) on a given date in the future (the futures contract’s expiration date).

An option contract is only binding for the option seller, but not for the buyer. When you hold an option, you have the right, but not obligation, to buy (if you have a call option) or sell (put option) the underlying asset at a given price (the option’s strike price) on a given date in the future (the option’s expiration date). You don’t have to use your right to buy or sell (exercise the option) – if you choose not to, you simply let your option expire.

Call Options vs. Put Options vs. Futures

There are two types of options: calls and puts.

When you buy a call option, you get the right, but not obligation, to buy the underlying asset. The seller of the same call option has the obligation to sell the underlying asset to you (the call option buyer) if you choose to exercise the option.

When you buy a put option, you get the right, but not obligation, to sell the underlying asset. The seller of the same put option has the obligation to buy the underlying asset from you (the put option buyer) if you choose to exercise the option.

When to Exercise an Option

Naturally, you only choose to exercise the option and buy (with a call) or sell (with a put) the underlying asset if it is profitable for you, given the market situation at the option’s expiration.

A call option is profitable to exercise when the underlying asset’s price is higher than the option’s strike price at expiration – in other words, when you can buy the underlying asset cheaper with the call option than without it.

A put option is profitable to exercise when the underlying asset’s price is lower than the option’s strike price – in other words, you can sell the underlying asset for higher price with the put option than without it.

Buying and Selling Futures

There are no call futures and put futures – futures only have one type. It is enough, because unlike with options, the rights and obligations of futures buyers and sellers are symmetrical.

Both the buyer and the seller of a futures contract have right and obligation to buy (futures buyer) or sell (futures seller) the underlying asset at the futures contract’s expiration. There is no thinking whether exercising is profitable or not – once you have a futures position, you have an obligation to buy or sell the underlying asset at expiration, regardless of the market situation at that moment.

If the buyer (or seller) of a futures contract no longer wants to buy (or sell) the underlying asset, the only way to avoid it is to neutralize his or her futures position by selling (or buying) the same futures contract (“close his position”).

Summary of Futures and Options Positions

  • Futures buyer has right and obligation to buy the underlying. Binding.
  • Futures seller has right and obligation to sell the underlying. Binding.
  • Call option buyer has right, but not obligation, to buy the underlying. Can choose.
  • Call option seller has obligation, but not right, to sell the underlying. Depends on option buyer’s will.
  • Put option buyer has right, but not obligation, to sell the underlying. Can choose.
  • Put option seller has obligation, but not right, to buy the underlying. Depends on option seller’s will.

What Futures and Options Have in Common

Besides the very significant differences explained above, futures and options have many things in common:

Both are derivative securities. This means they (and their prices) are derived from another security, called the underlying security or underlying asset.

Both options and futures exist on a wide range of underlying assets, including stock indexes, individual stocks, bonds and interest rates, currencies, commodities, and even weather. Generally anything that has price can also have futures and options traded on it. One more difference: While options on futures are common (a futures contract is the underlying for an option contract), futures on options are not.

As already mentioned, both futures and options can serve to delay buying or selling of the underlying asset, and thereby also to delay paying the full purchase price when buying an asset. Both futures and options provide leverage (the ability to control or get exposure to an underlying asset’s price without immediately paying the full price of the asset). This makes both futures and options popular with hedgers (who use futures and options as insurance against adverse price moves) and speculators (who use them to bet on and profit from price moves).

Futures vs. Options Margin

While both futures and options allow you to get exposure similar to owning an asset without paying its full price, you do have to pay something.

When buying or selling a futures contract, you deposit margin with your broker, as an assurance that you will honor your obligations. You also deposit a margin when selling options, although that margin is determined differently.

On the contrary, no margin is needed when buying options. Remember that unlike futures and unlike selling options, buying options does not result in an obligation to buy or sell the underlying. With no obligation, no assurance (margin) is needed. Instead, buy need to pay the option price (also called option premium) to buy the option.

Which Are Better to Trade?

Both futures and options can be very profitable to trade, but either can also lead to big losses when risk is not respected and managed properly (remember that leverage works both ways – it can amplify profits as well as losses).

Futures are simpler and faster to understand, particularly with previous stock or forex trading experience. New things to learn with futures are mainly margin and expirations, the rest is more or less the same as trading stocks or forex.

Options are more complex. While the price of a futures contract only depends on the current price of the underlying asset (and interest rate, but its effect is typically far less significant), option prices also depend on volatility. You should not attempt to trade options without at least basic understanding of how volatility works and how it affects option prices (and thereby your profits or losses). Differences between calls and puts, as well as the wide range on strike prices available for a single option expiration (which strike to trade?), also add to the complexity a beginning option trader must overcome.

That said, a huge advantage of options for beginner traders or those with smaller accounts, is that unlike futures, options allow you to trade with very small risk, if you choose the right option strategies.