Futures v Options
Hey guys, I'm an undergrad freshman right now, and I have a lot more to learn before I'm ready to tackle interviews for 2020 internships this summer. I've been learning a lot on different things within the market, but one I just can't seem to understand is the futures market. Futures seem pretty similar to options to me from what I've seen so far, and I don't really understand where its place in the market is. If anyone's got an answer, I'd appreciate a different perspective than investopedia for once.
Hey mdibene1, what a lonely thread. I'm here since nobody responded ...so maybe one of these discussions will help:
If those topics were completely useless, don't blame me, blame my programmers...
An option is an option to buy/sell. Futures contracts are obligatory contracts.
You purchase a contract to short sell Bed Bath and Beyond stock and buy it later. Stock goes up or down you have to buy it to repay the stock you sold.
You buy a put option for Bed Bath & Beyond at strike price X. by May 5th, you get the option but not the right to sell. If BB&Y is below price X, you sell the stock you own. If the option is not worth exercising, you can let the contract to sell BB&Y at price X expire. Here your losses are capped at what you paid for the option. (Call option gives the right to buy)
Futures and options are both derivatives contracts, so they are similar in that respect. They differ, however, in terms of structure and payoff.
A futures contract is very simple: you agree to buy or sell a specific quantity of a specific product at a specific price at a specific time in the future. For example, assume today is Day No. 1 and you buy the Day. No. 5 futures contract for x1 share of XYZ company for $10.00. In other words, in four days' time, you will be buying x1 XYZ stock at $10.00 no matter what. Day No. 5 arrives and the current price of XZY stock is $15.00. As per your futures contract, you buy x1 stock of XYZ from your counterparty for $10.00. You immediately turn around and sell your x1 stock on the market for $15.00, making a tidy profit of $5.00.
Options are a little more complex: they are the right (but, crucially, not the obligation) to buy or sell a specific quantity of a specific product at a specific price at a specific time in the future. It's similar in some ways to insurance. For an upfront cost (the premium) you have the right to buy or sell a product at a pre-determined time if you so choose. For example, on Day No. 1 you pay $1.00 for the option to buy x1 stock of XYZ at $10.00 (the strike price) on Day No. 5 (the expiry). Day No. 5 comes, and XYZ stock is worth $15.00. You exercise your option (meaning you choose to use it) and so buy XYZ stock for $10.00 plus the $1.00 premium already paid. You then turn around and sell XYZ for $15.00 on the market, making $4.00 profit. If, on the other hand, XYZ stock is trading at $5.00 on Day No. 5, you may choose not to exercise your option (i.e. buy the stock), and so have only lost $1.00 - the premium already paid.
This is a key difference to futures contracts. If you've bought the aforementioned Day No. 5 future for $10.00 on XYZ, and XYZ is trading at $5.00 on Day No. 5, you are still obliged to pay $10.00 for that stock, meaning your loss (should you immediately turn around and sell your XYZ stock) is $5.00.
This is a simplified version, however I hope it makes things a little clearer. Any questions, let me know.
This is exactly the type of explanation I needed, you should be working for Investopedia.
They don’t pay enough, mate
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