Difference between option and future trading ?

Derivatives are financial instruments which derive their value from underlying assets such as equity shares, commodities, currencies, and interest rates.

Futures and options are the two most commonly traded derivatives. Market volatility also plays a significant role in the trading of futures and options.It is imperative to understand the difference between options and futures to enable a better understanding of the derivatives. Here we mention below the major differences.

Definition

· Future - A binding agreement between two parties to buy or sell an asset at a certain time in the future at a pre-determined price is a future contract.

· Option - A non-binding contract in which an investor gets the option or right to buy or sell a financial instrument on or before a certain date in the future at a pre-determined price is an option.

Degree of Risk

· Future - In the case of futures, there is a higher degree of risk as the parties are under obligation to execute their part of the contract at the pre-determined price, even in the case of losses.

· Option - In the case of options, there is a lower degree of risk as compared to futures as the parties are under no obligation and the level of risk is restricted to the premium amount.

Scope of Profit

· Future - There is an unlimited scope of profit in futures and the potential of losses is also higher.

· Option - Options also provide an unlimited scope of profit but restrict the extent of losses.

Premium

· Future - You don’t have to pay any advance amount in the case of futures except a commission.

· Option - In the case of options, an investor needs to pay the premium amount before they enter into the contract.