Top 7 Differences Between Futures & Options  – YOU MUST KNOW!

Before we get into the difference between futures and options, let’s first understand how futures and options work with the example of bikes.

Content:

• What is Future and Options Trading
• What are Futures?
• What are Options?
• Futures vs Options
• Futures and Options Stock List

What is Future and Options Trading?

Firstly, you need to understand that both Futures & Options are contracts / agreements between 2 people. So the value of futures and options is derived from their underlying product/assets on which contract is made. The underlying asset may be a land, gold, share or any product/service. So whenever the price of the underlying rises, the price of futures and options also rises, and whenever the price of the underlying falls, the price of futures and options will also fall.

There are 3 types of futures and options in stock market:

• Equity Futures & Options
• Currency Futures & Options
• Commodity Futures & Options

Confused? Let’s understand Futures and Options in detail below:

Futures

It is a contract between people to buy or sell a particular stock, commodity or any product at a fixed price on a future date.

Let’s look at the example below:

• Dev and Ram are best friends.
• Dev owns a bike showroom. 
• Ram entered into a contract with Dev to buy a bike worth 1 Lakh in the next 3 months.

Why does Ram enter into a contract with Dev to buy the bike in 3 months instead of directly buying it right away?

Here’s why: Ram is currently short of funds and thinks the price of the bike will rise in the next 3 months. On the other hand, Dev agrees to enter into a contract as he thinks the bike prices may drop.

In the next 3 months, 1 of the following things may happen: 

1. The price of the bike might increase to ₹ 1,20,000 and Dev might incur a loss of ₹ 20,000.
2. On the other hand, the price of the bike might decrease to ₹ 75,000 and Ram might incur a loss of ₹ 25,000.
3. Or the price of the bike might remain the same. (no profit, no loss)

In the Futures Contract, both Dev and Ram cannot pull out of the contract for next 3 months. Doing so will lead to legal implications from either of the parties.

Similarly, in the stock market, investors buy stock futures if they expect the price of the stock to increase in the future and short sell if they expect the price of the stock to decrease in the future. Both profits & losses are unlimited in futures contracts.

Unlike the Dev and Ram scenario, in Stock Market Futures Contract, one can exit anytime they want by booking the profits or losses.

To get a complete understanding of The Futures Contract, click on this link to read the detailed article. 

Options

Options contracts are similar to Futures but with some differences. The difference can be better understood if we learn about Options Buying and Options Selling separately.

Option Buying: Unlike Futures Contract, here you will have to pay only the advance amount (premium) to enter into the contract and if the trade goes against you, you will lose the advance amount (premium) only. On the contrary, if the trade goes in your favor, you will make unlimited profits.

Option Selling: Here, you will receive the premium from the option buyer and the profits will be limited to the premium received only. On the contrary, if the trade goes against you, your losses will be unlimited.

Let’s consider the Ram & Dev scenario again: Ram enters into an Options Contract with Dev to buy a bike worth ₹ 1 lakh in the next 3 months, but this time pays an advance of ₹ 10,000 (Premium) to book the bike.

In the next 3 months, 1 of the following things may happen:

• The price of the bike might increase to ₹ 1,20,000 and Dev might incur a loss of ₹ 20,000.
• On the other hand, the price of the bike might decrease to ₹ 75,000 and Ram might incur a loss of ₹ 10,000. (If he pulls out of the agreement)
• Or the price of the bike might remain the same. (no profit, no loss)

Here’s the main difference between a Futures and Options Contract: In Options Contract, if Ram feels that the prices are gonna drop, he can pull out of the contract, and by doing so he will lose only the advance amount i.e. ₹ 10,000 but Dev does not have any such option of pulling out of the contract.

To get a complete understanding of The Options Contract, click on this link to read the detailed article. 

There is one more thing that you need to know about before moving forward. Click here to learn about what is hedging in the stock market.

Futures vs Options

Check out the difference between Futures and Options in the Tabular Form below: 

NSE Futures and Options Stock List

Check out the list of all Futures and Options Contracts listed on National Stock Exchange (NSE) below:

We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, and hence we bring you the important topics and areas that you should know: