How is options trading different from trading futures?
While both options and futures are derivative instruments and play key roles in hedging and speculation, they have distinct characteristics:
Commitment: In futures trading, both parties have an obligation to fulfill the contract. But in options, only the seller is obligated to honor the contract if the buyer decides to exercise the option.
Profit and Loss Potential: In futures, both buyer and seller have unlimited potential for profit and loss. On the other hand, in options, the buyer enjoys unlimited profit potential with limited risk (maximum loss is the premium paid), whereas the seller has limited profit (the premium received) but faces unlimited potential loss.
Premium: Options have a "premium," which is the price paid by the buyer to the seller to get the rights provided by the option. Futures don't involve premiums.
Imagine you believe the price of gold will rise in three months. Instead of buying gold now, you opt for a futures contract agreeing to buy gold in three months at today's price. If gold prices rise, you benefit. However, if prices fall, you still must purchase at the agreed higher price.
Alternatively, you could buy a call option for gold. If gold prices rise, you can exercise your option and buy at the previously agreed price, securing a profit. If prices drop, you can let the option expire, limiting your loss to the premium paid.
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