Differences Between Futures and Options Trading

In this article, we will discuss

• Futures vs Options: The Fundamental Differences
• The Key Differences Between Futures and Options Trading Strategies
• Make F&O Trading with Samco Securities

For seasoned investors and traders looking to expand their horizons beyond the equity market, the derivatives segment presents diverse trading opportunities. The most commonly traded derivative instruments in India include futures and options. Before you start F&O trading (or even if you already have), you need to ensure that you understand how these two types of derivatives differ from one another fundamentally.

This will help you better appreciate the differences between futures and options trading strategies. So, let us begin with the basics and decode how the two types of derivatives compare.

Futures vs Options: The Fundamental Differences

Futures and options both derive their values from different underlying assets like equity stocks, currencies or commodities. This is why they are known as derivatives. The similarities, however, end here. Beyond this, futures and options are different in many ways.

Futures are derivative contracts sold by one trader to another. The buyer of the futures contract has the obligation to purchase or sell an asset — as the case may be — at a specified price on a specified date. The futures buyer cannot choose to dishonour their obligation to trade in the underlying asset as per the terms of the futures contract.

On the other hand, an options contract does not impose any such obligation on the contract buyer. Instead, it only offers them the right to buy (in the case of a call option) or sell (in the case of a put option) the underlying asset at a specific price on a specific date. The buyer of the options contract can choose to either exercise this right or to let the contract expire without using the said right.

This sums up the primary difference between options and futures. The nature of these derivatives contracts also leads to several deviations in how you should trade these instruments. This brings us to the issue of differences between futures and options trading strategies and how you need to approach each market segment.

The Key Differences Between Futures and Options Trading Strategies

Options trading and futures trading involve different strategies and considerations. While many beginners in the derivative market may simply restrict their participation to the options trading segment, it helps to know how the two compare because both futures and options are suitable for hedging and limiting risk. So, let us delve into the key differences between futures and options trading strategies.

• Obligation vs Choice

As discussed above, in futures trading, the buyer must mandatorily buy or sell the underlying asset at the predetermined price on the date specified. This binding nature means both parties to the trade are committed to the transaction, irrespective of how the market conditions may be at expiry.

This is starkly different from options trading, however, where the buyer does not face any such ultimatum to buy or sell the asset by the specified date at the predetermined strike price. That said, the seller of the options contract (also known as the writer) is duty-bound to uphold the terms of the trade if the buyer decides to exercise their right to trade in the underlying asset.

• Risks and Returns

Another key difference between futures and options trading strategies lies in the risks involved and the potential returns you can expect. In futures trading, the risk and the potential returns are both theoretically unlimited (except in the case of futures settled in cash). Since the contract must mandatorily be fulfilled, you may face substantial gains or losses depending on how the market moves.

In options trading, however, the buyer only risks the premium paid for the derivative contract. The gain for the buyer can be potentially unlimited, depending on the position taken and the options trading strategy used. For options sellers, on the other hand, the risk is far more significant but the maximum gain is limited to the premium received for the contract sold.

• Upfront Costs and Margins

Another important aspect of unpacking the differences between futures and options trading strategies is to understand the upfront costs and margins involved. Futures trading requires a margin deposit which can vary greatly depending on the market volatility. This initial margin includes both SPAN and exposure margins. Over and above this deposit, an additional maintenance margin may be charged as required if the losses in an open position exceed the margin deposited.

This also applies to selling options. However, if you are the options buyer, you need not deposit any margin money. Instead, you need to pay the options premium to the options seller to take a long position in this market segment.

• Types of Strategies Utilised

Futures are mostly used for speculative trading or hedging. In the former, traders speculate on the possible direction of the underlying asset’s price movement and enter trades accordingly. In the latter, traders use futures to secure an open position in a different market segment — often in the segment where the underlying asset is traded.

Options trading is far more complex. It offers opportunities to create trading strategies with varying levels of complexity — from vertical or horizontal spreads to multi-legged options trading techniques. You can even adjust these strategies for different risk tolerance levels and market outlooks because different strategies work in different conditions like bullish, bearish, neutral or volatile markets.

• Flexibility in Strategy Execution

Before trading in the F&O market, you should also be aware of the flexibility-related differences between futures and options trading strategies. Futures trading is much less flexible because once you initiate a trade, the contract terms like the price, quantity and delivery date are fixed. You must either settle the contract at expiration or close the position beforehand.

With options, you get greater flexibility because these derivatives can be exercised at any time before expiration (for American-style options), or decisions can be made at expiration (for European-style options). The range of different strike prices and expiration dates also adds layers of strategic potential to your trading plan.

• Sensitivity to Market Conditions

To fully comprehend the differences between futures and options trading strategies, you should also be aware of how these instruments are affected by market conditions. Futures, in particular, are highly sensitive to daily market changes. This, in turn, directly affects the margin balance in your trading account.

On the other hand, options are impacted in various direct and indirect ways by the prevailing market conditions. They are sensitive to multiple factors like the direction of the market movement, the price volatility in the underlying asset and time decay — all of which significantly influence option pricing.

Make F&O Trading with Samco Securities

Futures trading may be simpler than options trading because of the limited strategy options involved. In the options market, you need to account for various inputs like the strike price, the implied volatility, options Greeks and more. Factoring in all these details can be time-consuming and challenging. Furthermore, building effective options trading strategies based on these factors can be nearly impossible.

Here is where opening a Samco account can help. Once you complete the Samco account opening process, you get access to a wide range of features and analytical tools like options chains, TradingView charts, options Greeks and more. You can even access Options B.R.O, Samco’s advanced options strategy builder, free of cost.

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