How Are Options Different than Futures?

While options and futures seem to have a lot in common, there are key differences

by Mark Fightmaster

    Published on Aug 28, 2015 at 10:50 AM

    At first glance, options and futures seem to have a lot in common. Both vehicles give you the opportunity to bet on the future performance of an underlying asset. Plus, both options and futures are based on a predetermined quantity of the underlying, and have a set expiration date. They can be used either to speculate or to hedge.

    That said, there are some key differences between options and futures. The most crucial distinction is the obligation involved. An options contract gives you the right to buy or sell the underlying asset upon its expiration, but not the obligation. Conversely, holding a futures contract imposes the obligation to fulfill its terms.

    In fact, whereas traders shell out a premium to buy an option contract, futures buyers pay what's called an "initial margin," which is essentially a down payment. The initial margin is then applied toward the total cost of the underlying asset at the appropriate time.

    At expiration, a long options position can be exited by either selling to close, or exercising if the option is in the money. Meanwhile, an expiring futures contract can be settled by either physical delivery of the asset, or with cash. However, a short futures position can be used to offset a long futures position and exit the trade, just as with long and short option trades.

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