Here we attempt to
explain basic difference between Future and Option Contracts
Premium
While you pay a fee
called the "premium" when buying stock options, there are no premiums
to be paid in a futures contract. The initial amount of money (known as
"Initial Margin") paid when you buy a futures contract is a fraction
of the price paid for the underlying stock. While wrinting options you receive
premium.
Obligations
Buyers of stock
options are not obligated to exercise the rights to buy the underlying stock at
all while buyers of futures contracts or
option writers are obligated settle difference
with cash market and pay mark to mark daily.
Liability
Buyers of futures
contracts and option writers are exposed
to unlimited liability should prices move against them while buyers of stock
options lose only the amount of money used to purchase those stock options.
Expiration
Buyers of futures
contracts can carry forward their
position by selling current month contract and buying next month or vice versa.
Options expire worthless if the
options are out of the money.
Versatility
Options trading is
a lot more versatile than futures trading as the unique combination of call
options and put options along with the premium on each contract made it
possible for options strategies that profit in all directions. Apart from arbitraging, futures trading
is basically single directional (you make money only when price moves in one
direction).
By now, it should
be clear that futures and stock options trading are two totally different
things with their own trading characteristics. Futures trading is an important
risk management and speculative technique while options trading has evolved to
become a stand-alone strategic investment. Futures should never be made a
replacement for stock options trading and stock options trading cannot replace
Futures as well. Both trading instruments serves different purposes and should
find their place in every well diversified portfolio.
