Options and futures are the most important and most liquid financial instruments in the futures markets. They have many common parameters, but they also have fundamental differences.
Concept and types of futures
Futures are futures contracts, an agreement for the supply of an asset (commodity) in the future on agreed terms. As assets of futures, both physical commodities (pork, gold, oil, grain, etc.) and specific financial instruments (bonds, stocks) can be used. Currency futures for buying and selling currencies can also be distinguished separately.
Futures are divided into buy and sell contracts. In most cases, the goals of buying futures are speculative, i.e. the buyer does not plan to purchase the product in the future. It aims to profit from the difference between the buy and sell prices of a futures contract.
Futures contracts have standardized time frames, expiration dates, and the quantity and quality of the goods supplied. For example, 1 contract for oil assumes the supply of 1 thousand barrels. oil with specified characteristics (for example, Urals). After the expiration of the contract (futures), the goods are delivered. But the fraction of futures that exists before delivery is less than 3%
Another purpose of buying futures is to hedge risks.
Concept and types of options
An option is a derivative financial instrument, which is a contract according to which the buyer or seller of an asset (security, commodity) gets the right to buy or sell this asset at a predetermined price at the moment fixed by the contract. In this case, the seller of the option is obliged to make a return sale / purchase of the asset in the future under the terms of the option.
There are three main types of options - call option, put option and double option. Accordingly, a buy option gives its owner the right to buy the underlying asset at a fixed price, a put option gives the right to sell the asset.
Options can be traded both on the exchange and in the over-the-counter market. The first are standard exchange contracts, they circulate similarly to futures. They have their own specification, only the size of the option premium is negotiated by the traders, other parameters are set by the exchange.
OTC options are not standardized - they are concluded on terms that are negotiated by the parties to the transaction. OTC market participants are large non-financial organizations. The purposes of buying options are speculative operations (making a profit) or hedging (minimizing risks).
How do options work? In a simplified form - the buyer acquires an option to buy 1 thousand dollars for 20 thousand rubles. In this case, the buyer expects that the price of the dollar will be much higher and he will be able to make a fairly profitable purchase at the end of the option expiration date. If by the end of the option term $ 1000 costs 30 thousand rubles, this difference (10 thousand rubles) will become the buyer's profit (excluding the cost of the premium).
Differences between futures and options
It is important to understand the difference between futures and options. The fundamental difference between these two instruments is that the buyer (or seller) of the futures undertakes to pay and receive one or another commodity at an agreed price. The owner of the option can also do this, but is not required to. But if the owner of the option wishes to use it, then the seller is obliged to fulfill the delivery.
A distinctive feature of futures trading is the ability of both the seller and the buyer to freely exit the market.
The option buyer does not get this right for free; he pays a premium for it (this price is for the possibility of making a deal in the future). When purchasing a futures, the buyer fully bears the risk of negative price dynamics of the contract, and the potential size of losses is unlimited. And if the option price has shown negative dynamics, then its buyer's risk is limited only by the amount of the premium.
Options involve a more complex calculation of risks, and the option price requires special calculation techniques. Therefore, this tool is used only by professional investors and traders.
