Futures and Options: What's the Difference? Wortechologies Money and Finance Information

In the 18 years that I've been in the financial investing business, I've gotten a lot of questions about different types of investments. For example, what are the differences between futures and options?

Futures

What are futures exactly? Futures are an alternative investment, even though they've been around since the 1800's. They're opportunities to buy contracts in gold, silver, corn, oil, and even the S&P 500 and DOW futures. It has an end date, unlike stocks, which you can hold forever. After a number of months, you have to either buy the contract or sell it into an open marketplace.

Difference between Options and Futures

There is a difference between options and futures. The trick with the options: there's what's known as a strike price. You have to know ahead of time what the price of something is going to be, and you can buy an option at that price. So if you think gold is going to be $1,100 in an option, you'd buy a $1,100 strike price option. With futures, there is no price. If you think the market is going up, you just buy; if you think the market is going down, you just sell into the marketplace and then let it ride as long as the contract has time left in it. There is no fixed price. You just buy into it, and whatever price you receive is the price you have.

Buy In

When you buy in, you put up what's called "earnest money." You put a little deposit on the full value of the contract. So if the corn contract is worth $5,000, they may ask you to put up $500, which is earnest money. At the end of the life of the contract three months from now, you have the choice whether you're going to buy the full amount or exit. In futures, you can exit at any time before the end occurs, but that's what happens at the end. With options, if you want a strike price at $1,100, it may cost $2,000 up front to buy that option. With futures it's not the same-- it earns money and you ride it out.

If you ride it out until the end of it, what happens to the $500 you put down? They mark to market. As you gain profits, they add money to it, and you can take your profits every day. If you're starting to lose money, it comes out of that $500. It can get down to zero or even greater than zero. So, that's the biggest difference; whereas, in options, whatever you put up, you can't lose more than that. If you buy a $2,000 option and it goes to zero, then you've lost all your $2,000. With futures, if the market really moves against you, you can owe more, and they'll make you put up more earnest money to keep the contract going. Ninety-seven percent of people never hold the contract until the end. Most of these people, when trading, use what's talked about in my book, Winning the Trading Game, stops -- options to protect themselves against the downside risk.

There are a lot of options when it comes to financial investing. Knowing the facts about the type of investments you choose will help you to invest your money wisely.

About the Author
Noble DraKoln is the author of the best-selling books Winning the Trading Game and Trade Like a Pro as well as the wildly popular Small Speculator Series: Futures For Small Speculators, Futures For Small Speculators: Companion Guide, and Single Stock Futures For Small Speculators, available on http://www.amazon.com. He is also a well-known Southern California educator through his investing seminars and mentorship program. He has been a futures investor, broker, and analyst for almost 14 years. You can subscribe to his free monthly newsletter at www.speculatoracademy.com Noble DraKoln may be contacted at http://www.speculatoracademy.com. Click here to view more articles by Noble DraKoln.