Future and option trading have both become hugely popular investment schemes in the last ten years, but the majority of investors can’t tell you the difference between futures, options, and mutual funds. Investment is always a smart option, but if you’re doing it carelessly, you’re just waiting to lose your money.
Both futures and options are types of derivatives, which means they are an instrument that derives their value from the original value of a particular asset. Derivatives are available in many fields, like the stock market, currency, indices, gold, and even petroleum. Any commodity or financial instrument that you can buy or sell is allowed to have a derivative.
What Are Futures and Options Used For?
Futures and options are mainly used for two purposes:
- Hedging: Prices for different commodities and stocks can turn out to be volatile and change at a moment’s notice. Futures and options allow investors to hedge their investments, which protects them against losing their money in one fell swoop.
- Speculation: Speculators often use derivatives to cash in on market volatility. For example, if an investor correctly predicts an upcoming rise in the price of a particular stock, they buy up shares while the price is still low, and sell when it rises.
How do Futures Contracts and Options Investments Differ?
The most significant difference between futures and options is that while futures gives a buyer the obligation to purchase an asset (and sellers to sell that asset), options give investors the right, but not an obligation, to buy or sell the asset during the life of the contract.
Let’s explore that in detail.
Futures: You Get the Obligation
A futures contract is one that gives an investor the inherent obligation to buy or sell an asset at a specified date, at a price already agreed upon. Once the contract is signed, there are no revisions: the assets must be bought or sold on the specified date and at the specified price, without exceptions.
These are mostly seen in cases of commodities like oil or petroleum, which can experience fluctuations in price due to circumstances.
For example, an oil company which sees trouble on the horizon might want to make sure that its product is sold at a predetermined price. This allows them to avoid the risk of the price falling and thus losing their profits.
The same benefits apply to the buyers. If a buyer thinks the prices of a commodity or stock will rise in the near future, a futures contract allows them to lock in a price upfront so they don’t have to shell out more money later on. This is why these are called true hedge investments since futures contracts are designed to hedge against risks.
Options: You Don’t Get the Obligation
Options are investments which are based on the value of a security or commodity. However, unlike futures contracts, investors have the right, but not the obligation, to buy and sell that asset at a particular price. This means if an investor doesn’t want to sell their shares (or their commodities), they can choose to hold onto them in hopes of their market price rising even further.
Typically, buyers have to pay a premium for options contracts, with the premium representing the rate to buy or sell the security. They retain the right to buy or sell their shares or securities until the contract’s expiration date, which is the final date by which the contract has to be used.
What Are Call Options and Put Options?
Call options and Put Options are two different types of options contracts on things like the mo investor app. Here’s how they differ:
- Call Options: Call options are simply offered to buy a stock at a specified rate before the expiration of the agreement.
For example, a call option to buy a stock at a price of Rs. 50 per share within the next three months lets investors purchase shares when the price rises to Rs. 60 (for example), thus making a profit of Rs. 10 per share.
- Put Options: Alternatively, put options are offers to sell a particular stock at a specific price. Put options let investors profit when the stock they opened a put offer for falls below the put price.
For example, if an investor opens a put offer for a stock worth Rs. 50 per share and the price falls to Rs. 30 per share, the investor makes a profit of Rs. 20 per share.
Conclusion:
Now that you know more about futures and options, it’s up to you to decide which one you’re going to invest in. Consider factors like your budget at hand, the commodities or securities you want to invest in, and market factors that might cause fluctuation in the near future. It’s worth keeping in mind, however, that since you’re only going to lose your premium investment in the case of options, these are usually the safer option by far.
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