Question

You are considering a futures position in the futures contract written on the STAR Index. This is an index consisting of technology stocks that specialise in inter-planetary travel, and the current index level is 18,746. Assume that is possible to short sell the index. The future value of dividends expected to be paid over the next year is $376 and the 1-year interest rate is 4%.

d. It is also possible to trade in options contracts on the STAR Index. Briefly distinguish the key distinctions between futures and options contracts.

Answer 1

Ans.

A. Yes it is possible to trade in options in an index futures ,as option as a hedging strategy was basically developed to be based on index and later on options on individual stocks and currency was developed. In the above case if one wants to trade on options and is expecting STAR index to go up can buy call option of index or sell put options and if one wants to have a bearish view on the index he can by put options of STAR index or sell call options .

B.A brief distinction between future and options.​​​​​​

1. Futures is defined as a contract between two parties in which one is buyer and other one is seller.Both the buyers and seller promise to each other to buy or sell the traded asset either by delivering the security or transferring money on or before the stipulated time ,whereas options is defined as exchange traded contract in which buyer and seller enter in to agreement to buy or sell securities on or before at.fixed . The predetermined price at which the trade is settled is known as strike price.

2. In case of future contract there is an obligation on both buyer and seller to settle the contract on or before expiry date whereas in the case of options buyer of an option contract has the right but no obligation to settle trade but the seller has the obligation to settle the trade .

3. Futures are generally more risky contracts than the options ,in case of future contract in index or stocks both the buyer and seller has the unlimited risk untill the contract is settled in case of options only the seller of options contract has unlimited liability but the buyer of option has liability limited to the extent of premium paid .

4.The buyer of the option contract has to pay only initial premium of the contract but in case of futures a predefined amount of margin is required to be maintained by both buyers and sellers of the contract till the time of closer of contract.