Over the past decade, derivatives trading has experienced significant growth and emerged as a mature industry in its own right. Two primary instruments dominate this space, namely options, and futures, and they are traded on almost all types of assets. Despite their popularity, however, these instruments remain widely misunderstood. At first glance, these terms may appear interchangeable, but it is important for traders to understand that there are both similarities and differences between the two concepts, and these distinctions can each be leveraged into an advantage.
Both options and futures are considered crypto derivatives — meaning that they do not have inherent value on their own but derive their value from the underlying instrument upon which they are based. Traders who engage in these types of trades enter into contracts or agreements that stipulate the terms of the transaction. However, there are important differences in the terms outlined in these contracts. This article will explore the similarities and differences between the two.
What are Options Contracts?
Options are asset instruments that provide the holder with the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a predetermined price — strike price.
One of the key advantages of options trading is the vast number of strike prices and expiration dates available, making it more versatile than futures trading. This variability in strike prices allows for adjustable leverage, making options trading suitable for those who prefer either a more aggressive approach or a more conservative one.
In the context of crypto options trading, the strike price depicts the predetermined price at which the underlying cryptocurrency will be bought or sold on or before the expiry date of the option. On the other hand, the spot price of a crypto asset refers to its current market price.
What are Futures Contracts?
Futures contracts are binding agreements to buy or sell an underlying asset at a fixed price at the end of the contract’s life. Futures trading involves a fixed level of leverage based on the initial margin required to enter into the contract, which is less flexible than options trading. Additionally, futures contracts have unlimited loss potential, making them riskier than option contracts.
When entering into a futures contract, the buyer is required to make a payment of a fraction of the underlying asset’s price. Both buyers and sellers of futures contracts are bound by the terms of the contract and are obligated to fulfill their respective obligations upon the contract’s expiration date. However, this can put both parties at risk if the price of the underlying asset doesn’t move in their favor.
Differences Between Crypto Options and Crypto Futures
One of the most notable differences between these two is that Future Trading is that you enter into an Obligation, whereas in Options trading gives you the Right to buy or sell the underlying asset at a fixed price
Other differences can be clearly seen based on several factors such as cost efficiency, risk level, and much more.
Generally, futures trading offers a better cost efficiency as no advance payment is required from the buyer to the seller, unlike options trading, where a premium must be paid upon issuance of the contract. However, there may be certain fees that must be paid based on regulations or the exchange where the trade takes place.
The future market is highly liquid and accessible due to its larger size. In comparison the options market, which can be significantly less liquid, can result in larger trades taking substantial time to settle.
Options contracts are less risky than futures as they provide the buyer with the right, but not the obligation, to make the purchase before the predetermined date. In contrast, a futures buyer is obligated to make the purchase on the predetermined date at the predetermined price, resulting in an uncertain loss if the underlying commodity performs negatively. With options, the maximum loss is limited to the premium paid.
Futures contracts are resistant to time decay as they can only be executed on a specific date, which does not affect the valuation of the contract when bought or sold. In contrast, options can be executed any day before the predetermined date, which can negatively impact its valuation as the trade date approaches, which shortens the time period to fully utilize the advantages that come with the contract.
Options trading also offers the freedom of execution, allowing the buyer to purchase the asset whenever the underlying markets are efficiently performing, whereas futures contracts can only be executed on a predetermined date.
Which is better?
While options trading is considered less risky, futures trading is better known for its cost-effectiveness. Ultimately, the decision to use either strategy will depend on a trader’s preferences for liquidity, risk appetite, and the assets supported by their chosen crypto exchange.
It’s worth noting that the future market has been established for a long time and is often considered less complex than the options market. However, the complexity of the options market provides traders with multiple routes to generate profits, an attractive strength. It is crucial to carefully consider these factors before deciding to trade crypto futures or options on any exchange.
Overall, while both options and futures are derivative financial instruments, options trading offers greater versatility due to the range of strike prices available, allowing for customizable leverage and risk management. Futures, on the other hand, have fixed leverage and unlimited loss potential, making them more dangerous and less flexible, but with strong options for success as well.
Disclaimer: The opinions expressed in this blog are solely those of the writer and not of this platform.