Options vs. Futures – Two Different Types Of Futures Contracts

Futures and options are futures contracts and are among the most important financial instruments for professional traders – alongside shares and ETFs. In this article we will talk about similarities and differences between options and futures, as well as their characteristics and possible applications.

Overview: Similarities and differences of options and futures

OptionsFutures
Derivative financial products includeDerivative financial products include
are traded on futures and options exchangesare traded on futures and options exchanges
conditional forward contractunconditional forward contract
unilateral commitmentmutual obligation
can be bought and sold (long & short position)can be bought and sold (long & short position)
directional & non-directional trades possibleonly directional trades possible
Trade with leverage possibleTrade with leverage possible
ideally suited for tradersideally suited for traders
are used by commercial market participants for hedgingare used by commercial market participants for hedging
mostly very liquid, for some underlyings illiquidvery liquid
tradable on most liquid futures, as well as on shares and ETFstradable on commodities, indices, energy, bonds, food, currencies

In the following we will go into some of the above mentioned points in more detail:

Exchange-traded futures contracts

Futures and options are traded on futures exchanges

Futures and options are standardized futures contracts and are traded on futures exchanges such as the CME in Chicago, NYMEX in New York or Eurex in Frankfurt. Whereas trading used to take place on the floor, nowadays futures and options are also traded almost exclusively electronically.

Both futures and options belong to the group of financial derivatives. They were mainly developed for commercial market participants to hedge against price fluctuations, but of course they also gave speculators and traders the opportunity to profit from them.

A future or futures contract refers to “something else” (underlying) – for example, a precious metal or a type of grain. The term of the future is limited. Each contract purchased is matched by exactly one contract sold. The buyer undertakes (if he holds the contract to maturity) to buy a certain quantity of the underlying at a certain price. The seller undertakes to deliver the underlying.

Options are conditional forward contracts

As just mentioned, futures are therefore an unconditional forward contract, as the buyer and seller enter into a commitment. The most important difference between futures and options is that the latter is a conditional futures contract.

This means that the buyer of the option – as the name suggests – has the option or the right to buy or sell the underlying in a certain quantity at a certain price, but not the obligation.

Imagine you own Apple shares and want to hedge against falling prices. You could buy an option to sell (put) on the stock market, which gives you the right to sell your shares at the current market price within a period of, say, 100 days. If the price falls, you can sell at the current market price and you will not suffer a loss; if the price rises, your shares will increase in value, but you will lose the option premium you have already paid.

Who trades in futures and options

Get to know the different market participants

To find out who is trading in options and futures, you only have to take a look at the weekly CoT report, which shows the number of open contracts of different trader groups. (commercial hedgers, large speculators, small speculators)

For example, we use Crude Oil WTI with the abbreviation CL. Let’s look at a weekly chart; below it we see the respective positions of the Commercials, the Large Speculators, as well as the Small Speculators – the number of long contracts held and the number of short contracts held.

(Note: For simplicity, this is the number of futures contracts held, excluding options. The numbers with options are very similar)

It is clearly evident that commercial market participants (hedgers) hold by far the largest number of contracts, followed by the major speculators. The small speculators (non-reportables) hold a comparatively small number of contracts.

Options and Futures for prviate traders

Which product is better suited for trading?

If you want to trade profitably, you need to know the markets you are trading in and the market participants. As we have seen, both futures and options are products that are mainly used by professional market participants to hedge against price fluctuations.

Futures and options therefore differ significantly from warrants, certificates or CFDs, for example, and as traders we find ideal conditions for profitable trading.

But is futures trading or options trading now better suited for private traders?

This question cannot be answered in a general way. Let’s take a look at which instrument is better suited for which trading approach:

Directional vs non-directional trading

In trading – especially in options trading – a distinction is made between directional trading and non-directional trading.

With most financial instruments, only directional trading is possible. This means that you go long or short and only earn money if the underlying moves in the direction you want.

With non-directional trades, however, you can also earn money if the underlying moves sideways or even against you or in both directions.

Directional trading with futures

With futures you can take long or short positions and thus profit from rising as well as falling prices. It is therefore an instrument with which you can only trade directionally.

Non-directional trading with options

With options, directional trades can also be made. However, options also allow non-directional trading. This means that instead of speculating on where the price will go, you now speculate on where the price will not go. With the right strategies, the chances of success are significantly higher than with directional trading.

In addition, you can speculate on rising or falling volatility and profit from it without “predicting” where the price of the underlying will go.


Read my other articles about options:

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