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Futures and options

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Futures and Options are derivative instruments derived from an underlying security.

Futures: Futures are a type of contracts where there is an obligation on the buyer to buy the asset and seller to sell the asset as per the terms of the contract.

In future, seller and buyers make a contract to buy the asset at the specified time at an agreed price in future. The contract is standardised in respect of delivery time, quantity and price.

For example: Suppose a garment manufacturer wants to buy 3000 metres of clothes, 3 months from now, in July. It makes a contract with a cloth mill to buy 3000 meters cloth at an agreed price in July. The garment manufacturer speculates that cotton price will be high in July so it is best to make a contract at the current price. Cloth mill estimates that cotton price will go down in July, so it is best to make a contract at the current price. On the expiry of the contract, both buyer and seller have to buy and sell the cloth at an agreed price whether they are in loss and profit.

Options: Options are a contract between buyer and seller to buy and share the price in future at a specified time in specified price at the non-refundable amount. The difference between Futures and Options is on the obligation it puts on a buyer. Options, unlike Futures, don't put the obligation on the buyer to buy on specified price. A buyer can buy or not on his will.

Options are categorized into to 'call' and 'put'.

Call Options: Calls provide the right to the buyer to buy the stock at a specified price under the specified time but don't put any obligation on it. If the buyer thinks that the price of the stock will rise in future he will buy the stock and if it goes down he will sell it. If the stock fails to reach the desired price before the expiration, the options expire and become worthless.

Put Options: Put options works opposite of call options. It gives the seller right to sell the stock at a specified price under the specified time before expiry. But the seller is not obliged to sell the stock.

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