Difference between options and futures

Q: What is the difference between options and futures?

A: The primary difference lies in the obligation placed on the contract buyers and sellers.

In a futures contract, both participants in the contract are obliged to buy (or sell) the underlying asset at the specified price on settlement day. As a result, both buyers and sellers of futures contracts face the same amount of risk.

On the other hand, the option contract buyer has the right but not the obligation to buy (or sell) the underlying asset. Hence the term "option" and this option comes at a price in the form of a premium (more specifically, the time value of the premium). With this "option", the option buyer's risk is limited to the premium paid but his potential profit is unlimited.

Sellers of options take on an additional volatility risk in exchange for the premium. However, their potential profit is then capped while their potential losses has no limit. Hence, this premium can be high if the underlying asset is perceived to be very volatile.

More Frequently Asked Questions

  1. What are the differences between standardized options and employee stock options?
  2. I recently bought a call option. Since then, the stock price has risen and so has the call option. I wish to sell my call option for a profit but am I obligated to deliver the underlying stock if the option buyer decides to exercise his call option?
  3. Does an increase in open interest imply a bullish sentiment?
  4. I own options on a stock that has just declared a 2 for 1 stock split. What happens to my options?
  5. Why do some stocks have options for trading while others don't?
  6. Can i be assigned if I buy-to-close a short position?

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