Futures vs. options: What’s the difference?
Editorial staff, J.P. Morgan Wealth Management
- Futures and options are derivative contracts commonly used for speculation and risk management by investors, but they operate in fundamentally different ways.
- Futures obligate traders to buy or sell assets at certain prices on specific dates.
- Options give buyers the option, but not the obligation, to buy assets at certain prices on specific dates.
- The better fit for you depends on factors like your risk tolerance, available capital and desired level of involvement.
As you become more confident with the fundamentals of investing, you may consider exploring other strategies to potentially enhance your portfolio – such as trading options and futures. While both instruments allow you to speculate on future price movements and hedge potential risks, they differ significantly in terms of cost structure and risk exposure. Read on for the basics you should know before opening a position in either.
What are futures?
Futures are standardized contracts that obligate you to buy or sell a specific asset at a fixed price on a set date in the future. For example, a futures contract might require you to buy 5,000 bushels of corn at $5 per bushel on July 20. But why would you want 5,000 corn bushels – or large quantities of other assets like gold or cattle? Most traders don’t. What they do want, however, is the opportunity to profit from price changes in those markets. Futures provide that opportunity, often without the need to ever touch the underlying asset.
To enter a futures position, you’ll need to post an initial margin, typically 2% to 10% of the contract’s total value. For example, a $25,000 contract may require a margin deposit of $500 to $2,500. The margin ensures you can cover a certain amount of potential losses. Once the position is open, your account is marked to market daily – meaning it’s adjusted daily to reflect your gains or losses. If the balance gets too low, you’ll be required to deposit more money to keep the position open.
Looking to invest in options?
We offer unlimited $0 commission online trades on a variety of options with a J.P. Morgan Self-Directed Investing account
Types of futures and potential outcomes from trading futures
Futures contracts can be grouped into two main categories based on the type of asset they’re tied to:
- Commodity futures: These involve physical goods, such as metals, agriculture, energy and livestock.
- Financial futures: These are based on financial instruments, such as stock indices, foreign exchange rates and interest rates or Treasury securities.
When you enter a futures contract, you’re speculating on the future price of the underlying asset, whether it’s a physical commodity or a financial instrument. One party agrees to buy the asset at a set price on a future date, while the other agrees to sell it at that price on the same date. Both are surmising where the price will go, but only one will be correct in the end. Here’s how it works:
- Profit: If the market price moves beyond the contract price by the contract’s expiration date, you’ll profit. The market price must go above the contract price for buyers and below the contract price for sellers.
- Loss: If the market price doesn’t move beyond the contract price by the expiration date, you’ll incur a loss. This happens if the market price stays below the contract price for buyers and above the contract price for sellers.
When a futures contract expires, it’s settled through either a cash settlement or the physical delivery of the underlying assets. In most cases, however, traders close out their positions before the expiration date through offsetting, or by entering an equal but opposite trade.
Example of how futures work
Suppose crude oil is at $72 per barrel and you think it’s going to go up in the coming months. You enter into a futures contract to buy 1,000 barrels at $75 per barrel, with delivery scheduled in three months. The total contract value is $75,000, but you need to post only a 5% margin ($3,750) to open the position. Here are two possible outcomes:
- Profit: If the price of crude oil increases to $80 per barrel after two months, the value of your contract will increase by $5 per barrel, totaling $5,000 (for 1,000 barrels). Your account would be credited $5,000 through daily mark-to-market adjustments. You could opt to offset the position and realize the gain.
- Loss: If the price of crude oil drops to $70 per barrel in a month, your contract’s value would decrease by $5 per barrel, or $5,000. The total would be debited from your account. If this causes your margin balance to fall below the maintenance margin, your broker will issue a margin call, which requires you to deposit additional funds. Exiting the position at this point would mean finalizing the $5,000 loss.
How investors may want to think about futures
Futures offer a way to gain large exposure with a relatively small upfront investment. They don’t provide built-in downside protection, though, so losses can exceed your initial margin and lead to margin calls. Futures also require you to actively manage your positions so you don’t end up with an unwanted delivery of assets or losses you can’t afford.
What are options?
Options are contracts that give you the right, but not the obligation, to buy or sell an underlying asset at a certain price (the strike price) by a certain date. Most standard options contracts represent 100 shares of the underlying asset – typically stocks, stock indices or exchange-traded funds (ETFs).
To buy an option, you’ll need to pay a nonrefundable premium per share upfront to the seller. Several factors, including the strike price, time until expiration and market price volatility, impact the premium cost of an options contract. After opening a position, the value of the option fluctuates based on market conditions, and traders can choose to close the position early or let it expire.
Options types and potential outcomes
Options contracts come in a few variations, but the two primary types are call options and put options:
- Call options: These give you the right to buy the underlying asset at a specified price within a certain time frame and are typically used when traders expect the price of an asset to increase.
- Put options: These give you the right to sell the underlying asset at a specified price within a certain time frame and are typically used when traders expect the price of an asset to decrease.
Whether you opt for a call or a put options contract, you’ll end up with one of the following outcomes:
- In the money: The price of the underlying asset moves in your favor, so exercising the option results in a profit. A call option is in the money when the market price is above the strike price, while a put option is in the money when the market price is below it.
- At the money: The strike and market price are the same, so exercising the option wouldn’t provide a profit. In these cases, the contract usually expires worthless.
- Out of the money: The price of the underlying asset moves against your position, so exercising the option isn’t profitable. In these cases, the contract usually expires worthless.
Example of how options work
Suppose you see a specific stock trading at $145 per share, and you expect the price to rise. You buy a call option that costs $1 per share – $100 total – which gives you the right to buy 100 shares of the stock at a strike price of $148 for two months.
- In the money: If the stock trades at $152 by the expiration, you could buy 100 shares at $148 and sell them at $152, earning a $4-per-share profit. After subtracting the $100 premium, you’d net a $300 profit.
- At the money: If the stock moves to $148 (at the money), the option would expire worthless, and you’d be out your $100 premium.
- Out of the money: If the stock’s price goes below $148, the option would expire worthless, and you’d be out your $100 premium.
Now, let’s say you expect a stock’s price to decline, so you buy a put option for a $1 premium. It gives you the right to sell the stock at $142 per share for two months.
- In the money: If the stock drops to $138 before the contract expires, you could buy 100 shares at $138 and sell them at $142, generating a $400 gross profit – $300 after accounting for the $100 premium paid.
- At the money: If the price stays at $142 (at the money), the option expires worthless, and you lose your $100 premium.
- Out of the money: If the price stays above $142, the option expires worthless, and you lose your $100 premium.
How investors may want to think about options
One of the main benefits of options is that the maximum loss is limited to the premium amount for buyers (also called holders) – you’re not obligated to exercise the option if it won’t benefit you. However, sellers (also called writers) may face significantly more risk, depending on their strategy. They receive the nonrefundable premium but are obligated to fulfill the contract if the buyer exercises their right. Options also offer leverage, allowing you to control 100 shares of a stock with a relatively small upfront investment, but it’s important to recognize that leverage does not exist without its own corresponding risk.
What are the differences between futures and options?
Futures and options are both derivative contracts that allow you to buy or sell assets at predetermined prices by certain dates. However, they differ in the following ways:
- Obligation: Futures obligate both parties to complete the transaction on the expiration date (unless the contract is offset beforehand). Options give the buyer the right to complete the transaction, as well as the right to let it expire with no action.
- Risk: Buyers of options aren’t at risk of losing more than their premiums. If the price doesn’t move in your favor, you can let the contract expire. Futures traders don’t have that protection. They face the prospect of “unlimited downside,” as losses can exceed the initial margin deposit if the market moves in an unfavorable direction.
- Settlements: Futures are marked to market daily, meaning gains and losses are settled daily. With options, gains or losses are realized only when the contract is sold, is exercised or expires.
- Costs: Options require the buyer to pay a nonrefundable premium per share upfront. Futures don’t have a fee but do require you to post a margin to cover potential losses you may incur.
- Quantity of assets: A standard options contract represents 100 shares of the underlying asset, while futures contracts can specify varying deliverables.
Futures | Options |
|---|---|
Obligation | |
Yes, for buyers and sellers | No for buyers, yes for sellers |
Risk | |
Potentially unlimited for both parties | Limited to premium for buyers, potentially unlimited for sellers |
Settlements | |
Marked to market daily | Realized when exercised, sold or expired |
Costs | |
No upfront premium, margin required to cover potential losses | Upfront premium per share |
Quantity of assets | |
Varies by asset | Typically 100 shares per contract |
How should you decide whether to invest in futures or options?
Now that you know the basics of futures and options, which is a better fit for you? Here are a few questions that can help you decide:
- What’s your risk tolerance? Buying call or put options may be a better fit if you prefer to limit your losses to a known amount. Futures could be better if you’re comfortable taking on the risk of larger losses in exchange for potentially higher returns.
- How much capital do you have to trade? Options typically require a lower and more predictable upfront cost (the premium). Futures require an initial margin to cover potential losses and may require additional deposits if prices move against you.
- How active do you want to be in the position? Futures are marked to market daily, which leads to daily balance fluctuations and potential margin calls. Options don’t have daily settlement, which means you can be more hands-off, unless you’re selling options or using advanced strategies.
- Do you want flexibility in your strategy? Options offer more flexibility than futures. You can use them for straightforward bullish and bearish bets, or even for complex strategies that consider factors like time decay and volatility. With futures, you’re either long or short, and profit or loss tracks with the asset’s price movements.
The bottom line
If you’re new to derivatives, options can offer a softer introduction. As a buyer, they allow you to define your maximum risk upfront, which won’t lead to margin calls. Futures, however, are often better suited to experienced traders who are comfortable with high leverage, daily price swings and active position management. Some traders use both, though, leveraging options for strategic risk management and futures for direct market exposure.
If you have any questions about how options or futures might best fit into your investment portfolio, a financial advisor may be able to help.
Frequently asked questions about futures vs. options
Stocks, also known as equities, are securities that represent ownership shares in a company. When you buy a stock, you become a partial owner and may receive benefits like dividends and voting rights. Futures are standardized contracts in which a buyer and seller agree that a named asset will be purchased or sold at a certain price on a designated date. These contracts are often used for speculation and hedging.
In addition to options, two common types of derivatives are futures and swaps. Futures are standardized contracts that obligate buyers and sellers to trade an underlying asset at a set price on a future date. Swaps are private agreements in which two parties exchange cash flows on scheduled dates based on changes to stock prices, interest rates or commodity prices.
Invest your way
Not working with us yet? Find a J.P. Morgan Advisor or explore ways to invest online.
Editorial staff, J.P. Morgan Wealth Management
