Futures contracts and Options contracts are widely used by everyone who uses the stock market to make money and wealth. The derivative market is one of the major tools to make money. Future contracts and options contracts are mainly included in the derivative market. The derivative market helps you to make huge money in a shorter period at the same time it will lead to losing money in a very shorter time. But if you know about these markets you can easily make money from them.
When you compare derivative market trading and intraday stock trading you will have one advantage. You can take delivery of a short sell. But in stocks intraday, you need to close that trade by end of the day. In futures and options, you can hold the trade till the expiry date.
A cash market is a marketplace where you can buy and sell shares. This is also known as the spot market.
A derivative market is a place where you can sell and buy futures and options. In futures and options, you are not buying and selling shares. Instead of that you are buying and selling contracts. This is commonly known as the derivative market. Contracts are made between a seller and buyer.
When we look into these futures and options, both are entirely different in nature. Here we are going to understand the major similarities and differences between future and options. We are going to cover topics like
- What is Derivative Market?
- What is the future contract?
- What is an Options contract?
What is Derivative Market?
A derivative market is considered a financial instrument or security that’s value is derived from an underlying asset. It includes credit default swaps, Future contracts, and Options contracts,
What is the future contract?
A future contract is a contract agreed between a buyer and seller to make the trade on a future date at the agreed price.
In future contracts, if the price of the agreed asset increased from the agreed money, then the buyer will get a profit. But on the expiry date if the money of the asset goes down still buyer needs to buy the product in this scenario seller will be in profit.
Example
Consider there are two-person one is person A and the other one is person B. Person A wants to sell his land and Person B Plans to buy that land. In this situation, they made a contract. Person A thinks that because of some reason price of land will go down before he needs to sell his land. But person B thinks that there is lots of development going to happen so the price of the land goes up. Here they made a contract like after one-month person B buys land from person A at the agreed amount.
What will happen after one month?
There are 3 possibilities that will happen
1 price of the land may increase
2 price of the land may be decreased
3 price of the land remains same
Consider the first situation, if the price of the land increased but person A will get the agreed amount from person B. here person B will have is profitable because the price of the land is high but he’s getting the land at less price
Consider the second situation, if the price of the land goes down but person A will get the agreed amount from person B. here loss happens to the buyer because the actual price of the land is less but the buyer needs to pay the agreed amount.
Consider the third situation, if the price of the land remains the same then there will be no changes to profit and loss for both parties because the contract is traded by the agreed amount only.
What is an Options Contract?
In option, the contract is a contract made by a seller and buyer here at the time of expiry buyer has the right to withdraw from the contract but in option, contract buyer needs to pay a premium amount to the seller which is not refundable at any time. When you compare future contracts with options contracts there will be some major differences you can identify.
There are 3 possibilities that will happen
1 price of the land may increase
2 price of the land may be decreased
3 price of the land remains same
Consider the first situation, if the price of the land increases but person A will get the agreed amount from person B. here person B needs to pay a premium amount to enter into the options contract. Here person B will have is profitable because the price of the land is high but he’s getting the land at less price
Consider the second situation, if the price of the land goes down. The buyer will face loss in this contract to avoid this option contract allows him to withdraw from the contract made with the seller. But he won’t get the premium amount that buyer paid to the seller.
Consider the third situation, if the price of the land remains the same then there will be no changes to profit and loss for both parties. In this situation also a buyer can withdraw from the contract. In any of these situations, the buyer won’t get the premium amount. If the buyer withdraws from the contract the seller will get the premium amount
If the buyer agreed to pay a higher amount it is called a call option. The opposite of this is known as the Put option. An option contract allows the buyer to risk only the premium amount at the same time seller will get the premium amount along with the agreed amount if the contract happens.
Conclusion
This blog post covers the basic fundamentals of the Derivative market, Future, and options. There is one main reason behind the use of future and options it’s included risk management and hedging purposes. With the use of small capital, the Investor can invest money and increase wealth. Nowadays people are using futures contracts and options contracts for trading instruments. In upcoming articles, we will explain this future contract and options contract in detail