Futures vs. Options

Many people buy and sell stocks or ETFs before getting into futures and options. These derivatives are more complex instruments that allow investors to incur greater risks in exchange for higher potential rewards. These contracts give investors exposure to the price movement of more assets than people who prioritize owning the underlying asset. This guide will explore how futures and options work so you can decide if either of them is right for you.

Main Takeaways: Futures vs. Options

There's a lot to explore when comparing these contracts, but these are the highlights.

• Futures represent a sale that will be made in the future. It is a contract that the purchase will happen sometime after the current period.
• Options are the option to buy or sell the stock. Options are further broken down into put and call options, which we explore below.
• Futures and options have their similarities but are traded in different situations.

What are Futures?

A purchase or sale of stock happens in real-time. Futures trading is a contract to make a sale or purchase in the future.

A futures contract has a buyer and a seller, both of whom agree that an asset will be bought or sold for a specific price on a specific day. The asset can be a commodity, a currency, or even an index, like the Dow Jones Industrial Index. A common use for futures contracts is to remove pricing volatility within commodity markets.

The volume of futures contracts can be an indication of where the price or index will move in the short term, but there are some subtleties to understanding futures volume. Another element must be considered, called "open interest," which is a measurement of how many orders haven't been executed because the price hasn't reached the price for those orders.

Trading Futures

Traders look for changes in volume, technical indicators, and other factors when trading futures. Rising volume combined with rising open interest can confirm a trend while rising volume and a falling open interest instead suggests a liquidation. Futures contracts are traded on futures exchanges, such as the Chicago Mercantile Exchange (CME); S&P 500 futures have the highest volume of futures contracts at the time of this writing, followed by the 10-year T-note, the 5-year T-note, crude oil, and then corn.

Futures contracts can represent nearly any index or commodity, but some indexes and commodities generate more interest and trading opportunities.

What are Options?

A stock option is a derivative because it's not the stock itself but rather an option to buy or sell the stock. Options give you the choice but not the obligation to buy or sell the underlying security. Investors who sell options are obligated to fulfill their end of the bargain if the contract holder wants to exercise the option.

Call Options

A call option is an option to buy at a future date. It's a bit like browsing at your favorite store and choosing an item for layaway — but there is a charge for putting the item on layaway. This charge, called the premium, is the cost of the options contract. It makes sense that there would be a charge because by buying the option you haven't actually purchased the item.

However, you can control that item, in this case, a stock, for a small fraction of the cost of purchasing the stock.

Put Options

A put option is an option to sell at a future date. Put options can be used in various investment strategies, including a bet on a market downturn, but one of the most common strategies is using put options as a simple insurance policy. Put options can protect your downside if the market makes a big downward swing. Let's say you bought shares in an S&P 500 index ETF (SPY) at $400.

Buying put options against those shares for 10% less than your purchase price of $400 allows you to limit your loss to $40 per share if the share price dips more than 10%. Of course, you'll have to pay a premium for this option and the option is only effective for a limited amount of time.

In that regard, it's a lot like insurance: you pay for it just in case you need it — but you may not ever need it. Like insurance, if you want continued protection, you'll have to renew your policy — or buy more puts in this case.

Trading Options

Options traders can exchange calls and puts. Calls gain value when the underlying asset's price increases, while puts gain value when an asset loses value. Options traders can either go long or short on an option. Long options traders pay a premium and then realize gains if the investment moves in the right direction. Short options traders sell these derivatives and realize a premium right away. These traders can lose money if the investment moves in an unfavorable direction.

Futures vs. Options: Similarities

Futures and options have several similarities. These are some of the highlights. 

• No margin, no service: Futures trading and options trading require margin accounts. This doesn't exclude IRAs entirely, but a third-party custodian for the account must be established as an extra hurdle. For retail traders, an individual brokerage account (with margin) is most frequently used, which also helps keep retirement investments separate from more exotic trades like futures or options trading.
• Insurance uses: Both futures and options can be a simple sort of insurance to either keep pricing within an understood range or to protect the downside for investment positions.

Futures vs. Options: Differences

While futures and options are similar, they also have a few key differences. These are some of the details to keep in mind.

• Contract dates affect trading: Futures contracts only allow the underlying asset to be traded on the date specified in the contract. Options can be exercised at any time prior to the option expiration date.
• Options are optional: Futures and options also differ in the requirement to make a trade. Futures are a trade — if held. In most cases, the futures contract is sold before the expiration date, preventing the trader from having to take delivery of 1,000 barrels of oil, live cattle, pallets filled with pork bellies — or whatever else is traded. Options, on the other hand, don't need to be exercised at all. If there's no business or investment reason to exercise the option, it can expire with the only cost being the premium for the contract.

Best Online Futures Brokers

Are you interested in trading futures? Take a look at the online brokers below to help you get started.

Best Online Options Brokers

Are you interested in trading options? Take a look at the online brokers below to help you get started.

Navigating Futures vs. Options

Futures and options are similar in many ways but often tend to be used for different purposes. A futures contract is the preferred vehicle for many active traders who want to profit from the up or down moves in the market.

Because of better liquidity, bid-ask spreads are usually closer to futures than with options, an important consideration when margins are slim and doubly important if you are working with a limited amount of cash in your trading account. Of course, if you have an industrial interest, futures are useful for managing the costs of commodities as well.

Options are a great way to insure your investment, protect your downside, or simply for speculation, betting on the rise or fall in a stock, index, or price of a commodity. More sophisticated options trades are also available for investors who want to combine put and call options or even create a "synthetic" position that behaves like a real holding of the underlying asset.

Ready to start trading futures or options? Check out Benzinga’s top picks for the best futures brokers or the best brokers for trading options. 

Frequently Asked Questions