Many investors want to invest in futures and options but need help understanding them. Options and futures are two kinds of financial derivatives in which investors speculate on market price fluctuations to deal with risks. Both allow investors to buy investments at a specific price before a date. But there are differences in the rules for options and futures contracts, leading to very different risks for investors. So what are their characteristics and differences, and how should investors choose? Follow our writing to learn more about these two investments.

What are Futures?

The full name of futures is the futures contract, a forward contract. Simply put, futures is to purchase future commodities or other financial assets at current prices. Futures contract was first born in the agricultural product trading market as a hedging tool to prevent uncertain future prices. Futures are opposite the spot. Traditional spot trading is to trade current goods, while futures is to sell future goods. A futures contract is between the buyer and the seller, agreeing on a price and a delivery date and paying a deposit. The transaction will be concluded at the agreed price on this specific date in the future.

Types of Futures 

Futures contracts can be divided into commodity futures and financial futures according to the agreed commodity type.

Commodity Futures

Commodity futures traders can trade commodities such as oil, gold, natural gas, and even sugar through futures contracts.

Financial Futures 

Traders of financial futures trade financial assets such as indices, stocks, and bonds.

Examples of Futures 

A farmer is worried that the price of crops will fall due to a bumper harvest of agricultural products in the future. At the same time, a businessman is worried that weather disasters will affect yields, resulting in reduced production and rising prices. So they agree to buy and sell a batch of crops at today's spot crop prices, and the delivery date is three months later. After the deposit is paid to make the contract come into being, no matter whether the crop price rises or falls three months later, the buyer and the seller must reach a deal at the agreed price.

Pros and Cons of Futures

Pros of Futures 

• Futures trading has high liquidity and extended trading hours. The trading hours of each futures contract are almost all day long, which allows futures traders to do what they want at any time. Compared with the stock market, it is less prone to gaps, which makes the futures market far more liquid than the spot market.

• Transaction costs are low. The only costs that need to be paid for futures trading are transaction tax and handling fees, while the handling fee of futures is fixed. Under normal circumstances, the performance cost of a futures contract is only a tiny part of the equivalent OTC transaction.
  

• Use small costs to achieve a big goal. Leverage enables the holders of futures to control a more prominent position at a lower price, and the hedger can reduce the risk it faces at a lower cost. Futures trading does not involve physically buying or selling underlying assets but uses margins to manipulate more considerable assets. Investors can take advantage of price fluctuations in the market to profit without committing vast amounts of cash.
  

Cons of Futures

• Futures must be settled monthly and cannot be used for long-term investment. If you choose the far-month contract, the liquidity of the contract could be better.

• Because of the leverage effect, the risk is high. Leverage is a double-edged sword, and it magnifies not only profits but also losses. If you make a mistake under the premise of using leverage, it may bring considerable losses to the principal. 
  

What are the Options? 

Options are a type of financial derivative. Options contracts give option holders the right to purchase commodities, which can be goods, securities, or other financial assets, at an agreed price within a specified period of time. The buyer pays the option premium to the seller, agrees on the purchased product's type, price, quantity, and expiration date, and concludes an option contract. Unlike a futures contract, the option holder is not obliged to fulfill the transaction when it expires.

Types of Options

Options can be classified in two ways. One is divided according to the rights of options, which can be divided into call options and put options. The other is divided according to the delivery date of the option, which is divided into American and European options.

Call Options

Call options refer to the right of the buyer to purchase a certain amount of specified commodities from the seller at the agreed price within the validity period of the options contract after the buyer pays a royalty to the seller, but the buyer has no obligation to buy. The seller of an option has a responsibility to sell a particular commodity at a price specified in the contract at the request of the buyer during the term of validity defined in the option contract.

Put Options

A put option means that after the buyer pays the premium to the seller, he has the right to sell a certain amount of specific commodities stipulated in the option contract to the seller at a price agreed in advance within the validity period of the option contract, but there is no obligation to sell. Obligation. The option seller is obliged to buy a specific commodity at a price specified in the option contract at the buyer's request within the validity period specified in the option.

American Options

American options refer to the options that can be exercised at any time within the validity period specified in the option contract.

European Options

European options refer to the options that can only be exercised on the expiration date stipulated in the option contract. The buyer of the option cannot exercise the right before the contract's expiration date. After the expiration date, the contract will automatically become void.

Examples of Options

The buyer and the seller agree to buy 10 ounces of gold at a price of US$1,800 per ounce after three months, and the buyer pays the option fee. If the price of gold exceeds $1,800 an ounce after three months, the buyer can still buy gold at $1,800 below the spot price, but if the price of gold falls below $1,800 an ounce, the buyer can choose not to Buy.

Pros and Cons of Options

Pros of Options

• The investment risk of options is low. Most individual investors need to refrain from using leverage in options trading. Without leverage, individual traders will hardly suffer unaffordable losses. As long as you rationally control the transaction scale before investing, you will not suffer significant losses.

• Low investment threshold. Various options are available to investors in the market, some of which are very cheap. This provides many opportunities for options investors to place low-priced bets.
  

• Trading hours are free. Unlike futures, options contracts are exercised for some time before a specific date. Compared with futures contracts that must be performed on a particular date, options investors have more room for choice and can choose the time they think is appropriate to perform the contract.
  

• The option buyer has no performance obligation. Regardless of whether there is a profit or not, the futures buyer must buy the goods on a specific date. But the option buyer can choose not to accept the specific commodity in the option if there is no profit.

Cons of Options

• Any investment has risks, and options are no exception. The most common mistake option investors make is investing much money without careful research and needing clarification on complex investment strategies, resulting in a loss of principal.
  

• Options can be exercised at any time before the expiration date. Options are different from futures in that the option buyer does not need to wait until a specific date to perform the contract. The agreed time of the option contract is the deadline for the buyer to exercise his rights. And many investors think that they have to wait until a specific date to start trading, which may miss the opportunity of price fluctuations or even expire.
  

• As an option seller, even if the price of the commodity on the expiration date is not beneficial to you, you must let the buyer exercise the right according to the provisions of the option.
  

• Many investors will try to buy some highly cheap options on the cheap. But there's a good chance these affordable options are worth nothing.

Similarities Between Futures and Options

1. Both options and futures require a margin account, and investors must establish a third-party custodian for the margin account before investing in options and futures. This can differentiate options and futures trading from other retirement investments.
   

2. Both options and futures have certain insurance functions. Since both options and futures agree on a price to buy commodities at a particular time in the future, both can effectively avoid sharp fluctuations in commodity prices and keep expenses within an acceptable range. 

Differences Between Futures and Options

1. Options and futures have different obligations. After signing the futures contract, when the date agreed in the contract arrives, the buyer must buy the commodities in the contract according to the contract requirements, regardless of whether the actual price of the commodity is profitable for the buyer at this time. But the option buyer has no obligation and can decide whether to exercise power according to the accurate price.
   

2. Trading dates for options futures are different. Futures contracts can only be traded on a specific date, while options have no specific trading day and can be changed at any time until the expiration date.
   

3. Futures contracts require margin payment. When signing a futures contract, traders do not need to pay an advance payment in advance, but the contract will charge a certain amount of margin. At the same time, leverage will also magnify the margin, so futures investors may make much money or magnify their losses.

How to Invest in Futures and Options? 

Trading options and futures requires opening a financial account, and you can open an account with Our. After opening an economic report, select the futures or options contract you want to trade. Futures contracts and options contracts are mainly divided into two categories: stock derivatives and commodity derivatives.

When trading stock market derivatives on a stock exchange, investors do not need to pay the accurate price of the selected target but need to pay a certain margin and the difference between the contract price and the accurate price. Among them, the trend of the futures contract is faster than that of the option contract, and the most extended period that the contract can agree on is three months.

To invest in commodity derivatives, you need to go to a commodity exchange. Commodity prices fluctuate considerably. In order to avoid heavy losses, investors can choose commodity derivatives options or futures. At the same time, due to the sharp fluctuations in commodity prices, investors still have the opportunity to benefit from the soaring commodity prices.

Who Should Invest in Futures and Options?

Whether it is options or futures trading, investors need to have a certain degree of understanding of the securities market, and investors need to monitor market changes for a long time to avoid losses. Also, both types of investments are highly speculative, so options and futures are better suited if you are a speculator or a hedger who wants to avoid wild swings in commodity prices.

Speculative traders usually judge future price fluctuations based on market sentiment and possible events. They typically go short, buy contracts at low prices, and invest long-term, waiting for opportunities to obtain high returns.

Another type of investor who is well suited to options and futures investing is the hedger. Compared with high returns, hedgers pay more attention to the hedging function of futures and options contracts. Hedgers usually choose to buy commodities with fast price fluctuations and large ranges for investment because futures and options contracts can guarantee specific price stability. Although the fixed price stipulated in the contract may also make investors lose the opportunity to make much money in the case of price fluctuations, the greater risk can be avoided regardless of the market price.

Special Considerations Before Invest in Futures and Options

Control transaction costs. 

Although the threshold for options and futures trading is low, many service fees and taxes may be incurred when trading. Moreover, options and futures transactions are highly liquid, and multiple transactions may occur in a short period of time. At this time, the investment cost for investors will increase rapidly. Therefore, before operating, we must carefully consider it.

Set stop loss and take profit points. 

Investors can set the maximum loss and profit. The former is to avoid losses exceeding the amount that investors can bear. The latter is to ensure that investors can make steady profits and avoid possible declines after the price rises to the peak. 

Use leverage sparingly. 

Many investors only notice that leverage will bring huge benefits and blindly increase leverage, but they forget that leverage can also magnify losses. Therefore, don't blindly enlarge the leverage, and make sure that the amount after the leverage effect is within the range you can afford.

Be aware of the risks. 

More significant benefits come with higher risks. Therefore, investors must follow profits. Before investing, investors must think about the range of risks they can take.

Final Thoughts

Now that you are well aware of the difference between options and futures when choosing one of them to invest in, you must make a decision based on your risk tolerance and investment style. Futures are riskier than options but have more significant opportunities to make money. Therefore, you must consider your goal before choosing an investment.