Many people are confused between options and futures trading. They thought both meant the same thing. These investment options are considered by some people to be quite risky. On the other hand, a proper understanding make it possible to profit. Those who use options and futures need to understand all the risks involved.
What Are Futures
In futures trading, the future price of a bond futures, stock index futures or a commodity futures is fixed. A trader agrees to sell while another trader agrees to buy the contract at the fixed price on the predetermined expiry date.
On the expiry date, if the futures contract is trading at a higher price than the agreed future price, then the buyer makes profit. However, if the futures contract is at a lower price, then the buyer makes a loss.
What Are Options
There are two different types of option contracts – calls and puts. The first is bought in anticipating that there will be an increase in the price. The put options are generally bought when the investor expects the price to decrease in future.
In the case of options trading, we can think of replacing options as futures in the previous example. The key difference is that options are really a right to buy or sell. When the buyer bought an option that makes money, he can exercise this right to get the underlying item in the option contract. However, when he made a loss, he can do nothing about it. His loss would only be limited to the money he paid for buying the option contract. In the case of futures, the buyer got to take physical delivery or close his position by selling the futures contract.
In this aspect, trading in futures is considered somewhat more risky than options trading. In futures trading, the buying trader can decide to take physical delivery of the assets, and go for the cash settlement, or choose to take the other side of the agreement.
Futures Trading Involves Physical Delivery
In futures trading, one party faces higher risk. This is because both buyer and seller need to sell or buy the assets at a fixed price on the contract expiration date.
Another difference is that in options trading, an option premium have to be paid upfront. Whereas in futures trading, the buyer used leverage in his trading account and no advanced payment is required. Generally the value of the futures contract is quite huge, such as 100k per standard contract. Many investors prefer dealing in futures because of this advantage.
These are the important considerations about both investment options, and it is important to know about them.
Secret To Options and Futures Trading Profits
It is better to trade after understanding the trends. Investment only be made if there is a high chance of making profit. One needs to avoid any emotional attachment and work according to a proven trading plan. Such a plan should have proper goals as well as exit and entry points. As futures is a riskier proposition compared to other investment options available in the financial market, use only the spare money, losing which will not cause any financial problem. All the reward and risk options must be evaluated properly. When it comes to options and futures trading, investors are advised not to over-trade.