Question

What are differences between an option and a futures contract?

Answer 1

Options are contract between two parties where the one agrees to buy the underlying asset from the other at a strike price prior to the expiration date. In options the buyer of the options gets an option to buy or sell the underlying asset at the strike price on or before the expiration date. It is not compulsory for the buyer of the option to buy the asset, in short there is no obligation.

The expiration of the contract can be done anytime before the expiration date. There is very little default risk as the options are traded on the market and the market becomes the counter-party to the agreement. Its a standardized contract. To book an option the investor has to pay a premium in advance. The best part about the option is that its a chance to earn unlimited profits and it restricts the loss to a limited amount.  

Future contract is also a contract between the two parties where one party agrees to buy the underlying asset from the other at an agreed amount. Here the investor has the obligation to buy the asset at the agreed price on the given date. In short there is an obligation for the investor.

The expiration of the contract is on the date given in the agreement. There is very high risk of default as the investor may back out from the deal if he gets a better deal from some other seller. The futures do not trade on the market and its a customized contract so the default risk is high. The premiums are not paid in advance. The futures are a risky product as it can lead to unlimited loss for any one of the party.