Futures & Options are the most preferred Derivatives for trading purpose.As name indicates “Derivatives” – prices are derived from some basic asset.E.g.In case of stock future, future price of that stock will be derived from the stock price.
There are few basic differences between futures & options which can be listed below:
Why Futures are called “futures” & Options as “Options”:
Futures – because there is prediction of “Future Value” of the underline stock.
Options – because it offers option holder an “option” to buy or sell the underlying asset [known as Exercising the option.]Of course,most of the positions are speculative in nature,option exercising is not that much common in capital markets.
Suppose Comex Gold trader buy Gold future contract at $1650, suppose he don’t square of the position before contract expiry & allowed to expire the contract then its become obligation for him to buy underline asset i.e.Gold .This is not case for Gold option buyer.Option holder will not have any such obligation to buy Gold but he will have rights to do so.
Option exercising is much useful in commodity markets especially agricultural commodities.
Future Value Vs Option Premium :
As futures are correlated to the spot value,future value need to be around the spot value with some discount or premium.This difference creates due to huge buying or selling positions build up in the future market.E.g If there is some big negative news around then there will be huge build up of selling positions by big investors & it will make the particular stock future to trade in discount. Premium or discount may not be at much higher level as it can easy arbitrage opportunity between spot & futures market.
Option Prices are known as option premium where only premium is payable by the option holder.Option price depends upon number of factors.One can read following post about the same:How Option Prices are calculated:
Risk :
Buying as well selling the futures carries the same risk.Any stock future can not become zero as basically such stock won’t be the part of F&O series.
While option buyer carries limited & known risk & option seller carry unlimited risk.
But its not the case that option buyers always make money.In fact most of the professional option traders believe that more money can be made by selling the option due to Time-Decay phenomenon as described below.
Time Decay Phenomenon –
Options are always subject to time decay as option price is function of time remaining for expiry.Options always expire worthless while this is not the case for futures.Positions in future market can be roll over in next contract.
Futures & Options are the the great Risk management tools & provide hedging opportunities for big traders.But remember its more about speculation and one should understand the underlying risk.
More Information about futures & Options :
Gold Futures – Best tool for short term View
Futures market Positions & Mutual Funds Regulations
Launch Of Option Trading At MCX-Sx.
How Commodity Future market works in India:
Silver Future Trading – What Beginners May Want To Know:
