Futures vs. Options

Newcomers to futures trading often confuse futures trading with equity options trading. But, they definitely are different investing approaches. The only similarity between a futures contract and an options contract is that they both have an expiration date. But a futures contract is not a wasting asset like an options contract.

Futures markets exist for the purposes of price discovery and the transference of risk. They can provide an excellent way to express your own opinion about where prices are heading. So if an option is a four-dimensional instrument, then a futures is simply a two-dimensional instrument. But they are very different from options.

An options contract conveys the right, not the obligation, to assume a position in the underlying instrument at a specific (strike) price any time before the option expires. When you buy (go long) an option, your risk is limited to the premium you pay. The cost of the option is known as a premium (similar to insurance) and is based on time, volatility and the relative value of your strike price to the underlying market.

However, the value of a futures contract is ultimately tied to the underlying product or instrument (e.g., S&P 500 Index, gold, crude oil, U.S. Treasury bonds or notes, soybeans, etc.) via each contract's specifications. You can either buy (go long) or sell (go short) any futures contract and your risk (or potential profit) is virtually unlimited.

However, what you know about options trading may be extremely useful when you enter the futures trading world. That’s because futures exchanges also list options on futures contracts. Just as in equities, you can take an options position that defines your risk on a position that has a futures contract as the underlying instrument.