- Futures and Options are types of derivative contracts where two parties agree to buy/sell an underlying asset at a predetermined price on a future date.
- They help hedge market risks by locking in prices in advance.
- The underlying asset can be stocks, indices, commodities, ETFs, etc.
Key Differences Between Futures and Options
| Aspect | Futures | Options |
|---|---|---|
| Obligation | Mandatory to buy/sell on the agreed date | Right (but not obligation) to buy/sell |
| Risk | Higher (both parties are liable to fulfill the contract) | Limited for buyer (only premium lost if not profitable) |
| Flexibility | Less flexible | More flexible (buyer can withdraw if unfavorable) |
Types of Options
| Option Type | What it Means |
|---|---|
| Call Option | Right to buy an asset at a predetermined price in the future |
| Put Option | Right to sell an asset at a predetermined price in the future |
Who Should Invest in Futures & Options?
1. Hedgers
- Aim to reduce risk from price fluctuations.
- Example: A farmer fixes a price today for future crop sales to avoid losses if prices fall.
- Physical trade is common in commodities.
2. Speculators
- Predict price movements to profit from market volatility.
- Take long positions if expecting prices to rise, or short positions if expecting prices to fall.
- Generally opt for cash settlement rather than physical delivery.
3. Arbitrageurs
- Profit from price differences between markets.
- They buy in one market and sell in another to benefit from temporary price imbalances.
- Their activity helps stabilize prices and eliminate inefficiencies.
Leverage in Futures and Options
- Traders use leverage, meaning they only deposit a small percentage (margin) to control larger positions.
- Can amplify both profits and losses, making proper risk management essential.
Risks Involved
- High risk due to unpredictable price movements.
- Requires a deep understanding of:
- Stock market dynamics
- Underlying asset behavior
- Economic conditions and news
What Is Open Interest?
Open interest is the total number of outstanding derivative contracts for an asset—such as options or futures that have not been settled. Open interest keeps track of every open position in a particular contract rather than tracking the total volume traded.
- Futures and options are powerful financial tools for hedging, speculating, and arbitrage.
- They can generate substantial returns but come with significant risks, requiring skill and market experience.
