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EducationalAugust 28, 2020

Futures vs Options: Which Should You trade and Why?

Shubham Goyal
Product Specialist
August 28, 2020

Options and futures are popular derivative contracts. This means that these financial instruments are connected and derive their values from an underlying asset. While at a quick glance, these might look similar in nature since both allow an individual to buy or sell an underlying asset or security at a later date. However, both are fundamentally distinct. Let’s check out how.

Options vs. Futures: What’s the Difference?

Under an options contract, a contract holder has a right but not an obligation to buy or sell the underlying asset or security at an already predetermined price.

However, under a futures contract, a person is under obligation and must buy or sell the underlying asset or security at a pre-agreed price and at a specific date.

In simple words, options are similar to a futures instrument, but where the contract holder has a legal right and authority to deny the trade of the underlying asset.

Examples

Options

Say, Jack likes Ray’s car and wants to buy it for 2 BTC but is unsure at the moment. Now, he may take out an options contract with Ray, where Jack will have a right but not an obligation to buy Ray’s car for 2 BTC at any time in the next 6 months. Here, Ray will receive a premium as per the contract, say 0.25 BTC, for extending that right to Jack. Now, Jack may or may not buy Ray’s car. But after a period of 6 months, the contract will expire, with or without any trade made.

Futures

A factory owner requires scrap iron from their production. Seeing the current lucrative market rate, the factory owner can take out a futures contract with a scrap dealer where at the end of the year the dealer will sell him scrap iron at 1 ETH/kg. Now, at the end of the year, the dealer is under an obligation to deliver the scrap iron at 1 ETH/kg, and the factory owner is under an obligation to buy it.

Options and futures are both excellent financial instruments that can be used to make money or to hedge investments. But a striking difference in their contract makes their market, work-and-react extremely differently. Let’s check out a few benefits of futures over options.

Futures vs Options: The Benefits of Futures Contracts

#1 Cost-efficient

A futures contract does not require you to make any advance payment to the seller. This is directly in contrast with options where you have to provide a premium to the seller on the issuance of the contract.

However, there are certain commissions that you might have to pay based on regulations or the exchange where the trade takes place.

#2 Resistant to time

The passage of time does not have a negative impact on the futures contract since the trade can be executed at a said date only. So, there is not much impact on the valuation of the contract whenever you buy or sell it.

However, options can be executed any day before the pre-decided date. This generally negatively affects its valuation, whenever the trade date starts to come near. This happens because it shortens the time period to fully utilize the time advantage of an options contract.

#3 Size

Since the futures market is a bit old and large, futures tend to hold more quantity of the underlying asset. Such is not the case with options contracts, where smaller units of assets may be dealt with.

Big traders and market players generally throng the futures market turning it a highly systematic arena with additional pros as listed in the coming benefits of futures over options.

#4 Highly liquid

The future market is much larger as compared to the options. This makes them highly liquid and accessible. The options market can be significantly less liquid, where bigger trades can take substantial time to settle.

#5 Tax benefits

Future trades are generally tax-friendly. A future trader tends to enjoy tax benefits as compared to an options trader, or even an equity trader. This generally results in more retention of profits generated after the tax cut in the futures market.

Futures vs Options: The Benefits of Options Contracts

#1 Lower risk and loss

Options contracts are less riskier than futures. Say if an underlying commodity, say Bitcoin, is performing negatively, a futures buyer has to make the purchase on the predestined date and at the predetermined price. The loss incurred by the buyer in case of futures can not be ascertained.

However, if there had been an options contract in the same scenario, then the buyer can opt-out of the deal and not make the purchase. Therefore, the maximum loss in an options contract is the premium paid.

#2 Freedom of execution

In an options contract, a buyer has a right but not an obligation to make the purchase whenever he wants before the predetermined day. This gives an option holder the right to buy the asset whenever the underlying markets are efficiently performing.

There is no such privilege in futures where the contract will be only executed on a predetermined day.

#3 Flexibility

A buyer holding an options contract is empowered by the flexibility to execute or avoid exercising an options contract.

#4 Place of Trade

The options trade can take place on and off the exchange. However, a futures trade is typically made only on the exchange and governed under strict rules and authorities. This is not true for trading cryptocurrency futures, of course, as they enjoy lower regulations.

trading futures vs options

Crypto Futures vs Options Trading: Which strategy is better?

Crypto future and crypto options have seen some remarkable growth in popularity in recent times, owing to their unique set of advantages for crypto traders. While options are less riskier, futures are much more cost-effective. The decisions a crypto trader takes lie on their preferences for liquidity, risk appetite, and even the assets that crypto exchanges support for these instruments. Pick the best cryptocurrency exchange, and you’re unlikely to be restricted in terms of choices.

Of course, there are other factors to keep in mind – such as your comfort with leverage, your understanding of margin trading, and more. If you’re looking to dive deeper, check out this in-depth guide to trading cryptocurrency options, or this in-depth guide to trading crypto futures. Crypto traders may also want to understand better the meaning of Support, Resistanceand other trading terms

Here, one observation is deserving of a mention. The future market has been long established and is often seen as less complex than the options market. However, this complexity of the options market is their strength, which allows multiple routes through which profits can be generated. You must weigh this aspect before trading crypto futures or crypto options on any exchange.

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