Options and Futures: Differences and Strategies

Options and Futures: Differences and Strategies

Options contracts are also consistent contracts allowing investors to trade an underlying asset at a pre-decided price and date.

Options and Futures with green and red triangle.

On the other hand, futures contracts are contracts for trading an underlying asset on a future date at a pre-determined price. These are consistent contracts traded on an exchange permitting investors to buy and sell them.

Difference between Futures and Options

Let us have a look at the differences applicable to Futures and Options in detail:

Futures with green triangle.

Futures

1. A futures contract is an agreement binding on the counterparties for buying and selling of a financial security at a fixed price at a particular date in the future.

2. Since futures contract is binding on the parties, the contract has to be honored on the pre-decided date and the buyer is locked into the contract.

3. For securing a futures contract, separately from the commission amount paid no advance payments are considered as compared to an options contract which makes it essential to make a premium payment. This is done for the purpose of securing the promise made by the parties.

4. The implementation of the futures contract can only be ended on the pre-decided date and according to the conditions which have been mentioned.

5. Furthermore, a futures contract can have no limits amounts of profits/losses to the counterparties. While options contract have unlimited profits with a cap on the number of losses.

6. And also no factor of time decay is significant in futures contract since the contract is certainly going to be executed.

7. The fee related with futures trading is easier to understand since most of the fees stay continuous and includes commissions on the trade, exchange fees, and brokerage. Other expenses pertaining to margin calls are also involve which also does not change much.

8. However, futures contracts also offer chance for speculation in that a trader who forecasts that the price of an asset will move in a particular direction. It can contract to buy or sell it in the future at a price which will yield a profit.

Options with green triangle.

Options

1. On the other hand, an options contract enables the investor the right but not the responsibility to exercise buying or selling of a financial instrument on or before the date of expiry.

2.Subsequently, an option contract provides just the option but no responsibility for buying or selling of the security.

3. Options contract requires the performance to be ended at any time earlier to the date of expiry.

4. Whether an option contract will execute will be much clearer while coming closer to the date of expiry, therefore making time value of money a significant factor. The premium amount paid also considers this factor while calculations.

5. The ownership of an option does not normally enable the owner to any rights related with the underlying asset, such as voting rights or any income from the underlying asset, such as a dividend.

6. There are two types of options: call options and put options. A buyer of a call option has the right to buy the underlying asset for a certain price. The buyer of a put option has the right to sell the underlying asset for a certain price.

7. And the owner of an option might on-sell the option to a third party in a secondary market, in either an over-the-counter transaction or on an options exchange, depending on the option.

See also: Futures and Options: A Quick Comparison

Strategies

Long Futures

So the simplest strategy with futures is to find a stock you think is moving upper, and buy a futures contract instead of the stock itself.

Going long or short involves buying or selling a contract now to take advantage of increasing or decreasing prices in the future.

Moreover, long futures positions may make sense when you are bullish on the market and uncertain about volatility. You will not affect by volatility changing.

On the other hand, if you have an outlook on volatility and that outlook turn out to be right, one of the other strategies may have better profit potential and/or less risk.

Short Futures

As well as, futures make it very easy to take a short position when you think a stock or index is going to drop in price. While there can be rules and prices to take a standard short position, the short future is just as easy as the long future to trade.

Additionally, the short futures position is an unlimited profit, unlimited risk position that can be entered by the futures investor to profit from a drop in the price of the underlying. The short futures position is also using a producer to lock in a price of a commodity that he is going to sell in the future.

Long Synthetic Futures

As a matter of fact, a synthetic futures contract, or synthetic long futures contract, is a position in which the investor purchases a call option and sells a put option at the same time. Both options must have the same strike price and expiration date.

Short Synthetic Futures

On the other hand, a synthetic short futures contract can duplicate by placing a long put option accompanied by a short call.

Long Risk Reversal

A risk reversal is a position which simulates profit and loss behavior of owning an underlying security; therefore it is sometimes call as a synthetic long. 

Generally this position is started as a follow-up to another strategy. Its risk/reward is the same as a LONG FUTURES except that there is a flat area of small or no gain/loss.

Nevertheless, rather than going long on the stock, investors will buy an out of the money call option, and at the same time sell an out of the money put option. Most probably investors will use the money from the sale of the put option to buy the call option. Then as the stock goes up in price, the call option will be value more, and the put option will be value less.

Call and Put in dice.

Long Call

However, a long call gives you the right to buy the underlying stock at strike price A. Calls may use as an alternative to buying stock outright. You can profit if the stock increases, without taking on all of the disadvantage risk that would result from owning the stock.

Furthermore, long calls offer an important growth potential and investors realize gains when the market price increases above the strike price. For example, the price that the option is exercise.

Short Call

While a short call is an options strategy in which a buyer takes a bearish opinion of a stock, bond or futures position. It gives the holder of the option the right, but not the obligation, to sell a security.

Moreover, a call option is a contract that gives the trader the right to buy a stock, bond, commodity or other instrument at a set price, within a particular window of time.

Long Put

The longput option strategy is a basic strategy in options trading where the buyer purchase put options with the certainty that the price of the underlying security will go significantly lower than the striking price before the expiration date.

When you are long a put you are expecting that the price of the underlying stock or index falls lower than the strike price of the put option.

Short Put

A short put refers to when a trader opens an options trade by selling or writing a put option. The trader who purchases the put option is long that option, and the trader who wrote that option is short.

Furthermore, a short put is the sale of a put option. It is also refer to as a naked put. Shorting a put option means you sell the right buy the stock. In other words you have the responsibility to buy the stock at the strike price if the option is exercise by the put option buyer.

Bull Spread

To clarify, a bull spread is a bullish, vertical spread options strategy intended to profit from a moderate rise in the price of the underlying security. Due to put-call parity, a bull spread can create using either put options or call options.

Moreover, bull spread is an option that traders use when they try to make profit from an anticipated rise in the price of the underlying asset. It can make by using both puts and calls at different strike prices.

See also: Bull Market: Clever Things to do before it Ends

Bear Spread

To explain, a bear spread is an option strategy that will profit when the price of the underlying security declines. The strategy involves the simultaneous buy and sale of options, where either puts or calls can be used.

Moreover, a bear call spread contains of one short call with a lower strike price and one long call with a upper strike price. Both calls have the same underlying stock and the same expiration date.

See also: What to do during a Bear Market

Long Butterfly

A butterfly is a limited risk, non-directional options strategy that is intended to have a high probability of making a limited profit when the future volatility of the underlying asset is anticipated to be lower or greater than the implied volatility when long or short respectively.

A long butterfly position will make profit if the future volatility is lower than the implied volatility.

Short Butterfly

The short butterfly is a neutral strategy like the long butterfly but bullish on volatility. It is a limited profit, limited risk options trading strategy.

Long Iron Butterfly

The long iron butterfly is a limited risk, limited profit trading strategy that is structured for a bigger likelihood of making a smaller limited profit when the underlying stock is perceived to have a low volatility.

Short Iron Butterfly

The short iron butterfly is another volatility strategy and is the opposite of a long iron butterfly, which is a range bound strategy.

The short iron butterfly involves putting together a bear put spread and a bull call spread. The greater strike put shares the same strike as the lower strike call to make the short butterfly shape.

In other words, the resulting position is profitable in the event of a big move by the stock. The problem is that the reward is seriously covered and is usually dwarfed by the potential risk if the stock fails to move.

Sell and Buy word.

Long Straddle

A long straddle is a mixture of buying a call and buying a put, both with the same strike price and expiration. Together, they create a position that should profit if the stock makes a big move either up or down.

Short Straddle

A short straddle is a combination of writing uncovered calls (bearish) and writing uncovered puts (bullish), both with the same strike price and expiration. Together, they produce a position that expects a narrow trading range for the underlying stock.

Long Strangle

The long strangle, also known as buy strangle or simply “strangle”, is a neutral strategy in options trading that include the simultaneous purchasing of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying stock and expiration date. 

Short Strangle

The short strangle, also known as sell strangle, is a neutral strategy in options trading that involve the simultaneous selling of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying stock and expiration date.

Ratio Call Spread

The ratio call spread is a neutral strategy in options trading that involves buying a number of options and selling more options of the same underlying stock and expiration date at a different strike price. It is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience little volatility in the near term.

Ratio Put Spread

The put ratio spread is a neutral strategy in options trading that involves buying a number of put options and selling more put options of the same underlying stock and expiration date at a different strike price. 

Call Ratio Backspread

Call ratio backspread is a term use to define a very bullish investment strategy that combines buys and sales of options to make a spread with limited loss potential and mixed profit potential. Traders use calls backspread strategies when they anticipate the price of the underlying to rise. Gains can be important if the underlying financial instrument meetings.

Put Ratio Backspread

A put ratio backspread is an options trading strategy that combines short puts and long puts to make a position whose profit and loss potential depends on the ratio of these puts.

In detail, a put ratio backspread is so called because it seeks to profit from the volatility of the underlying stock, and combines short and long puts in a certain ratio at the discretion of the options investor. It is constructed to have unlimited potential profit with limited loss, or limited potential profit with the prospect of unlimited loss, depending on how it is structured.

Box or Conversion

Occasionally, a market will get out of line enough to justify a first entry into one of these positions. On the other hand, they are most usually use to “lock” all or part of a portfolio by purchasing or selling to make the missing “legs” of the position. These are alternatives to closing out positions at possibly unfavorable prices.

Final Thoughts

As discussed above, both futures and options are derivatives contract having its customization as per the requirements of the counterparties. Options contract can reduce the number of losses unlike futures contract but futures offer the security of a contract getting execute at a certain date.

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