Economics Derivatives Questions
The key differences between options and futures are as follows:
1. Contractual Obligation: In futures, both the buyer and seller are obligated to fulfill the terms of the contract at the expiration date. On the other hand, options provide the buyer with the right, but not the obligation, to buy or sell the underlying asset at a predetermined price within a specific time period.
2. Risk and Reward: Futures involve unlimited profit potential and unlimited risk, as both parties are obligated to fulfill the contract. Options, on the other hand, have limited risk as the buyer can choose not to exercise the option if it is not profitable.
3. Price Determination: Futures prices are determined by the market forces of supply and demand, whereas options prices are influenced by the price of the underlying asset, time remaining until expiration, volatility, and other factors.
4. Flexibility: Options offer more flexibility as they can be used for various strategies, such as hedging, speculation, or generating income. Futures are primarily used for hedging purposes or for speculating on the future price movements of the underlying asset.
5. Initial Investment: Options require the payment of a premium upfront, which is typically lower than the margin required for futures contracts. Futures contracts require a higher initial investment in the form of margin.
6. Market Accessibility: Options are commonly traded on exchanges, making them more accessible to individual investors. Futures, on the other hand, are often traded on specialized exchanges and are more commonly used by institutional investors and professional traders.
Overall, options and futures serve different purposes and have distinct characteristics, making them suitable for different trading and risk management strategies.