24 November 2009
Future is a contract between a buyer and a seller, which binds the buyer to purchase and the seller to sell the stock or commodity at a future date at a fixed price.
An option on the other hand is the privilege sold by one party to another that offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security at an agreed-upon price during a certain period of time or on a specific date.
As an example, If you buy a future of Reliance at Rs 730 for the date 25th Sept 2005 on 10th Aug 2005 when the reliance stock is trading at Rs 705, You are bind to buy the reliance stocks at Rs 730 on 25th September 2005 and the seller is bound to deliver it whatever is the stock price at that time. Usually once you buy the future, it can be traded at the stock exchanges like a regular security and book profits/losses in between this time period.
If you buy a call option of reliance for 10 at a strike price of Rs 730 for the date 25th Sept 2005 on 10th Aug 2005 when the reliance stock is trading at Rs 705, you have the option to buy the stock any time before 25th September 2005 buy paying Rs 730. But you are not obligated to buy the stock. You have the option to let the contract expire without hurting you. You will loose the Rs 10 paid to buy the option.
Similarly, if you buy a put option in Reliance for Rs 10 at a strike price of Rs 690 for the date 25th September 2005 on10th August 2005 when the stock is trading at Rs 705, you have the option to sell the stock any time before 25th September 2005 for Rs 690 irrespective of the current market price. But you are not obligated to sell the stock. You have the option to let the contract expire without hurting you. You will loose the Rs 10 paid to buy the option.
The premium you pay for a particular strike price keeps varying on stock exchanges. The difference is usually your loss or gain.
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