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What are the key differences between Futures and Options?​

​​​​Futures and options are both derivatives, but they have distinct characteristics that set them apart. Here are the key differences:
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1. Contract Type
  • Futures: A futures contract obligates the buyer to purchase an underlying asset (e.g., commodity, currency, stock, or index) at a predetermined price on a specific date in the future.
  • Options: An option contract gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price (strike price) on or before a certain date (expiration date).
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2. Obligation
  • Futures: Both parties in a futures contract are obligated to fulfill their obligations, i.e., buy or sell the underlying asset at the agreed-upon price.
  • Options: The buyer has the right, but not the obligation, to exercise the option. The seller (writer) of the option has the obligation to fulfill their side of the contract if the buyer exercises their option.
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3. Risk Exposure
  • Futures: The buyer and seller are exposed to unlimited risk, as the losses can be significant if the price of the underlying asset moves against them.
  • Options: The buyer's maximum loss is limited to the premium paid for the option, while the seller's maximum loss is limited to the premium received, plus any potential losses if they are forced to buy or sell the underlying asset at an unfavorable price.
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4. Time Value
  • Futures: Time value is minimal, as futures contracts are usually settled on a specific date in the future.
  • Options: Time value is significant, as options have expiration dates and their value decreases as time passes.
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5. Flexibility
  • Futures: Futures contracts are standardized and traded on exchanges, with limited flexibility in terms of customization.
  • Options: Options are highly customizable, allowing buyers and sellers to tailor their contracts to their specific needs.
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6. Trading Style
  • Futures: Traded on exchanges, with prices quoted in terms of a specific underlying asset and expiration date.
  • Options: Traded on exchanges or over-the-counter (OTC), with prices quoted in terms of a strike price and expiration date.
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Example: Futures vs. Options in Action

Futures Example:
  • You buy 1 crude oil futures contract at $80 per barrel (1,000 barrels per contract).
  • If the price rises to $90, you gain $10,000 (i.e., (90-80) × 1,000).
  • If it drops to $70, you lose $10,000.

Options Example (Call Option):
  • You buy a crude oil call option at $80 strike price, paying a $2 premium.
  • If oil rises to $90, you can buy at $80, making a $8 profit per barrel ($10 gain - $2 premium).
  • If oil drops to $70, your maximum loss is just the $2 premium.​

Key Takeaways

Futures contracts are binding, while options give the right but not the obligation to execute.
Futures require margin, while option buyers only risk the premium paid.
Futures profits/losses are unlimited, while option buyers have limited risk.
Options are more flexible (calls & puts), while futures are direct commitments.
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