What is a futures contract, and how does it differ from options?

A futures contract is a legal agreement to buy or sell an asset at a predetermined price on a specific future date. Unlike options, futures require the buyer and seller to fulfill the contract, whereas options give the holder the right but not the obligation to execute the trade.

• Futures are binding contracts, meaning both parties must complete the transaction.
• Options provide flexibility, as the holder can choose not to exercise the contract.
• Futures are mainly used for hedging and speculation, while options are used for risk management.

1. How Do Futures Contracts Work?

A futures contract involves two parties agreeing to buy or sell an asset (such as stocks, commodities, or currencies) at a set price on a future date. These contracts are standardized and traded on exchanges.

• Buyer Obligation: Must purchase the asset at the agreed price.
• Seller Obligation: Must sell the asset at the agreed price.
• Leverage Factor: Futures allow traders to control large positions with a small margin.

2. Futures vs. Options: Key Differences

Feature	Futures	Options
Obligation	Mandatory execution	No obligation to execute
Risk	Higher risk due to leverage	Limited to premium paid
Purpose	Hedging & speculation	Risk management & trading

3. Pros and Cons of Futures Contracts

Advantages:

• High Leverage: Allows traders to control large positions with a small investment.
• Hedging Tool: Used by businesses to manage price risks.
• High Liquidity: Actively traded in global markets.

Disadvantages:

• High Risk: Due to leverage, losses can be significant.
• Mandatory Execution: Unlike options, futures must be fulfilled.
• Market Volatility: Prices can swing drastically.

4. Conclusion

Futures and options are powerful trading instruments that help investors hedge risks and make profits. However, due to their complexity, understanding their differences and risks is crucial before investing.