Futures and options are both derivative contracts that enable an investor to buy or sell an investment for a certain price by a certain date. Although they share similarities, they work quite differently and pose different risks for investors.
With an options contract, the holder has the option (but not the obligation) to buy an underlying asset, such as stock in a business, for a specified price by a specific date. A futures contract requires the holder to buy the asset on the agreed-upon date (unless the position is closed out before then).
The underlying asset for a futures contract is often a physical asset, such as commodities like grain or copper, but you can also trade futures on stocks or an equity index, such as the S&P 500. The underlying asset for an options contract can be a financial asset like a stock or bond, or it could be a futures contract.
Key Points
• Futures contracts make obligations about trading an underlying asset at a set price and date.
• Options give the buyer the right, not the obligation, to trade the underlying asset.
• Futures are riskier due to high leverage and daily mark-to-market adjustments.
• Options buyers risk only the premium paid, while futures leverage amplifies gains and losses.
• Both futures and options are used by hedgers and speculators for different purposes.
Main Differences Between Futures and Options
Although futures and options are similar, as they are both derivative contracts tied to an underlying asset, they differ significantly in terms of risk, obligations, and the ways in which they are executed.
How Futures Work
Futures contracts are a type of derivative in which buyers and sellers are obligated to trade a specific asset on a certain future date, unless the asset holder closes their position prior to the contract’s expiration.
A futures contract consists of a long side and a short side, where the short side is obligated to make delivery of the underlying asset, and the long side is obligated to take it (unless the contract is terminated before the delivery date).
Both options and futures typically employ some form of financial leverage or margin, amplifying gains and losses, increasing potential risk of loss.
How Options Work
Options trading consists of buying and selling derivatives contracts that give the holder the right, but not the obligation, to buy or sell an asset at a specified price (the strike price) by the contract’s expiration date.
• The options buyer (or holder) may buy or sell a certain asset, like shares of stock, at a certain price by the expiration of the contract. Buyers pay a premium for each option contract; this represents the cost of acquiring the option.
• The options seller (or writer), who is on the opposite side of the trade, has the obligation to buy or sell the underlying asset at the strike price, if the options holder exercises their contract.
There are only two types of options: puts and calls. Standard equity options contracts are for 100 shares of the underlying security.
💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.
The Role of Risk
Trading options come with certain risks. The buyer of an option could lose the premium they paid to enter the contract. The seller of an option is at risk of being required to purchase or sell an asset if the buyer on the other side of their contract exercises the option.
Futures can be riskier than options due to the high degree of leverage they offer. A trader might be able to buy or sell a futures contract putting up only 10% of the actual value, known as margin. This leverage magnifies price changes, meaning even small movements can result in substantial profit or loss.
With futures, the value of the contract is marked-to-market daily, meaning each trading day money may be transferred between the buyer and seller’s accounts depending on how the market moved. An option buyer is not required to post margin since they paid the premium upfront.
The Role of Value
Futures pricing is relatively straightforward. The price of a futures contract should approximately track with the current market price of the underlying asset, plus any associated costs (like storage or financing) until maturity.
Option pricings, on the other hand, is generally based on the Black-Scholes model. This is a complicated formula that requires a number of inputs. Changes in several factors other than the price of the underlying asset, including the level of volatility, time to expiration, and the prevailing market interest rate can impact the value of the option.
Holding constant the price of the underlying asset, futures maintain their value over time, whereas options lose value over time, also known as time decay. The closer the expiration date gets, the lower the value of the option gets. Some traders use this as an options trading strategy. They sell options contracts, anticipating that time decay will eat away at their value over time, expire worthless, and allow them to keep the premium collected upfront.
Options come with limited downside, since the maximum loss is the premium. Futures, however, can fall below zero: the contract’s value is tied to the underlying asset’s price, meaning traders may have to pay more than the contract’s original value.
Here are some of the key differences between futures and options:
| Futures | Options |
|---|---|
| Buyer is obliged to take possession of the underlying asset, or make a trade to close out the contract. Seller is obligated to deliver the asset or take action to close the position. | Buyer has the right, but not the obligation, to buy or sell a certain asset at a specific price, while the seller has the obligation to fulfill the option contract if exercised. |
| Futures typically involve taking much larger positions, which can involve more risk. | Options may be less risky for buyers because they are not obliged to acquire the asset. |
| No up-front cost to the buyer, other than commissions. | Buyers pay a premium for the options contract. |
| Price can fall below $0. | Price can never fall below $0. |
Understanding Futures
Futures contracts are similar to options in that they set a specific price and date for the trade of an underlying asset. Unlike options, that give the holder the right to buy or sell, futures investors are obligated to buy at a certain date and price.
Among the most common types of futures are those for commodities, with which speculators can attempt to benefit from changes in the market without actually buying or selling the physical commodities themselves. Commodity futures may include agricultural products (wheat, soybeans), energy (oil), and metals (gold, silver).
There are also futures on major stock market indices, such as the S&P 500, government bonds, and currencies.
Rather than paying a premium to enter a futures contract, the buyer pays a percentage of the market value, called an initial margin.
Recommended: Margin Account: What It Is and How It Works
Example of a Futures Contract
Let’s say a buyer and seller enter a contract that sets a price per bushel of wheat. During the life of the contract, the market price may move above that price — putting the contract in favor of the buyer — or below the contracted price, putting it in favor of the seller.
If the price of wheat goes higher at expiration, the buyer would make a profit off the difference in price, multiplied by the number of bushels in the contract. The seller would incur a loss equal to the price difference. If the price goes down, however, the seller would profit from the price difference.
Who Trades Futures?
Traders of futures are generally divided into two camps: hedgers and speculators. Hedgers typically have a position in the underlying commodity and use a futures contract to mitigate the risk of future price movements impacting their investment.
An example of this is a farmer, who might sell a futures contract against a crop they produce, to hedge against a fall in prices and lock in the price at which they can sell their crop.
Speculators, on the other hand, accept risk in order to potentially profit from favorable price movements in the underlying asset. These may include institutional investors, such as banks and hedge funds, as well individual investors.
Futures enable speculators to take a position on the price movement of an asset without trading the actual physical product. In fact, much of trading volume in many futures contracts comes from speculators rather than hedgers, and so they provide the bulk of market liquidity.
Understanding Options
Options buyers and sellers may use options if they think an asset’s price will go up (or down), to offset risk elsewhere in their portfolio, or to potentially enhance returns on existing positions. There are many different options-trading strategies.
Example of a Call Option
An investor buys a call option for a stock that expires in six months, paying a premium. The stock is currently trading at just below the option’s strike price.
If the stock price goes up above the strike price within the next six months, the buyer can exercise their call option and purchase the stock at the strike price. If they sell the stock, their profit would be the difference in the price per share, minus the cost of the premium.
The buyer could also choose to sell the option instead of exercising it, which can also result in a profit, minus the cost of the premium.
If the price of the stock is below the strike price at the time of expiration, the contract would expire worthless, and the buyer’s loss would be limited to the premium they paid upfront.
Example of a Put Option
Meanwhile, if an investor buys a put option to sell a stock at a set price, and that price falls before the option expires, the investor could earn a profit based on the price difference per share, minus the cost of the premium.
If the price of the stock is above the strike price at expiration, the option is worthless, and the investor loses the premium paid upfront.
Who Trades Options?
Options traders often fall into two categories: buyers and sellers. Buyers purchase options contracts — be they calls or puts — with the hope of making a profit from favorable price movements from the underlying asset. They also want to limit potential loss to the premium they paid for the option. Sellers can potentially profit from the premium they’ve collected when writing the options contract, but they face the risk of having to fulfill the contract if the market moves unfavorably.
The Takeaway
Futures and options are two types of investments for those interested in hedging and speculation. These two types of derivatives contracts operate quite differently, and present different opportunities and risks for investors.
Futures contracts specify an obligation — for the long side to buy, and for the short side to sell — the underlying asset at a specific price on a certain date in the future. Meanwhile, option contracts give the contract holder (or buyer) the right to buy or sell the underlying asset at a specific price, but not the obligation to do so.
Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.
Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.
Explore SoFi’s user-friendly options trading platform.
FAQ
Are futures more risky than options?
Both options and futures are considered high-risk investments. Futures are considered more risky than options, however, because it’s possible to lose more than your total investment amount.
Which uses more leverage: futures or options?
Typically, futures trading uses more leverage, and that’s part of what makes futures higher risk, and potentially appealing to speculators.
Which is easier to trade: futures or options?
Options strategies can be more complicated, and in some ways futures contracts are more straightforward, but futures trading can be highly speculative and volatile.
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