Which is more profitable futures or options contract: Because of the various advantages offered by the futures and options segment, it has gained a lot of popularity among individuals in the stock market.
They offer lower risk, good leverage and high liquidity and individuals use these financial instruments for the purpose of hedging and speculation.
But when it comes to the choice of investing in one of these instruments a question arises in the minds of individuals: which is more profitable, futures or options contract?
In this article, we will be discussing the answer to the question “which is more profitable futures or options contract?”
What Are Futures And Options Contracts?
Let’s try to understand what are futures and options contracts, Keep reading to find out more!
Futures contract – Meaning
Futures contracts are derivative instruments whose value is derived from an underlying asset. The underlying asset can be stocks, commodities, currencies, etc.
These contracts are entered between two parties, that is buyer and seller to be executed at a predetermined date and at a predetermined price.
Upon the date of expiry, both parties are obligated to execute the contracts, irrespective of whether they are earning a profit or incurring a loss
Options Contract – Meaning
Options contracts are exactly the same as futures contracts, but with the exception that the buyers of the contract have the choice of executing or not executing the contract upon expiry, and the sellers are obligated to honor the contract if the buyer decided to do so.
Here the buyer of the options contract pays a premium to the seller for the privilege of the choice of execution. Here the buyer has the right because he pays a premium at the time of entering of the contract and the seller has the obligation because he receives the premium.
Now that we have understood the meaning of futures and options contracts, let us look at the benefits of each of these contracts.
Benefits Of Futures Contract
Here are a few of the advantages of trading a futures contract:
- As the value of the futures contract is directly derived from an underlying asset, the price of the futures contract moves in direct proportion to any movement in the underlying price. The Beta of the Futures contract is always 1.
- The futures contract can be rolled over to the next month’s contract by settling the difference between the current future contract and the next future contract.
- Another major advantage of a futures contract is its liquidity. As futures contracts have a very narrow bid-ask spread, individuals can easily enter and exit a contract whenever they require.
- As the futures contract pricing is based on a cost-of-carry pricing model, the pricing is easier to understand.
Benefits Of Options Contract
Here are a few of the advantages of trading an options contract:
- The buyer of the options contract has a choice of not executing the contract if the contract does not go in his favour by expiry.
- The buyer of the options contract can benefit from the price momentum of the underlying asset by only paying the premium
- Writers of the options contract have a higher chance of the options going in their favor due to the Option Greeks factor (especially Theta or Time factor) and they receive the premium upfront.
- As the loss that can be incurred by the buyer of the option is limited to the premium paid, the return on investment for the buyer is higher.
Which Is More Profitable? – Futures Or Options?
Now that we have understood the benefits of both futures and options contracts. Let us now see which is more profitable futures or options contracts.
Well, there is no definite answer to the question of which contract is more profitable, it all depends on the risk appetite and the margins available to the individuals. But here are a few points that can help to select the right contract based on your preference:
- In case you opt to trade in a futures contract, the probability of you being profitable is more when the price of the underlying is moving in your favor. This is because a futures contract does not deal with time decay and the change in the price of the futures contract is at par with the change in the price of the underlying. But the margins required to invest in a futures contract are high.
- In case you opt to buy an options contract, you will have a higher return on your investment as the loss that can be incurred will be limited to the premium paid and the profit potential can be unlimited. But if you are the buyer of the options contract, the chances of you being profitable decrease as the options move closer to expiry. This is because the greeks work in the favor of the buyer of the options.
- In case you opt to become the writer of the options contract, you receive an upfront premium and the chances of the option going in your favor are high as the greeks work in favor of the writer. But the margins required to become an options writer are huge and the losses that can be incurred as a writer can be unlimited
In this article, we cover the meaning and benefits of futures and options contracts and also gave an answer to the question “Which is more profitable futures or options contracts?”
Through this article, it can be understood that both financial instruments have their own set of pros and cons. An individual should enter a position in one of these instruments based on his/her risk appetite and the margins he/she has available.
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