Difference between futures contract & options contract
What is the basic difference between a futures contract and an options contract?
Both futures contract and options contract are known as derivative contracts. In a futures contract, there is an underlying, the notional amount and an expiry date. In the case of an options contract, apart from the above, there is also a strike price.
The fair value of a futures contract is determined by the cost of carry and corporate actions of the underlying, if any. However, the fair value of an options contract is determined based on the implied volatility of the underlying.
The option premium is determined based on Black Scholes formula or based on binomial method of calculating the premium on options contract. The risk-reward of futures contract is symmetric and for option contract it is asymmetric.
In the case of options contract for bought call option position, the profit potential is virtually unlimited while the maximum loss is the call premium paid. In the case of sold call option, the profit is restricted to the premium received while the potential loss is unlimited.
In the case of bought put option, the maximum profit is the strike price while the maximum loss is the premium paid. In the case of sold put option, the maximum profit is restricted to the premium received while the maximum loss is the strike price as reduced by the put premium.