The equity derivatives market is huge in India. The main component of Indian derivatives market is futures and options. Both of them are very different from each other. In this article, we will discuss the difference between futures and options trading. However, before understanding the differences it is important to learn their basic meaning.
What is Futures Trading?
Future trading is a contract that involves the obligation to buy or sell the shares at a predetermined price in the future. In futures trading, the assets are traded at a predetermined price. The future contracts are traded on the exchanges like the equities and require a demat account to trade in them. The different types of financial futures that can be traded include stock futures, index futures, commodity futures, currency futures, etc.
What is Options Trading?
Options trading is a contract that provides the trader the right but not the obligation to sell or buy the assets at a specific price on a specific data known as the expiry period. Options contracts can be classified into calls and puts. The call option contract holder has the choice to buy the underlying asset by a specific date at the pre-determined price. Therefore, there is no obligation to purchase the asset. Similarly, a put option contract holder has the choice to sell the underlying asset by a specific date at a pre-determined price. Again, the contract holder does not have the obligation to purchase the assets.
Differences Between Futures and Options Trading
· In a futures contract, the contract holder must take ownership of the underlying asset at a predetermined price and date. While in the case of the option contract, the contract holder has the right but no obligation to purchase the underlying asset. The option contract holder can either trade or terminate the agreement before the expiry date of the contract.
· Future trading is very risky in comparison to options trading. In options trading, the loss is limited only to the premium amount paid.
· There is no requirement for advance payment in the futures contract. On the other hand, the activation of a futures contract requires you to pay an upfront premium amount.
· In futures trading, there is no limit to losses or profits. While in the case of options trading, the profits are high and losses are limited.
· Price can fall below 0 in the futures contract. While the price of an options contract can never fall below.
Understanding the differences between futures and options trading is essential to take more informed decisions in the stock market. When you know how the derivatives markets function and how their price movements take place, you can trade much more efficiently in the market.
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