Financial Question in obligations of buyers and sellers

Business & Finance
Tutor: None Selected Time limit: 1 Day

Compare the rights and obligations of buyers and sellers of futures contracts with the rights of buyers and sellers of options contracts. 

Nov 11th, 2014

A: The primary difference lies in the obligation placed on the contract buyers and sellers.

In a futures contract, both participants in the contract are obliged to buy (or sell) the underlying asset at the specified price on settlement day. As a result, both buyers and sellers of futures contracts face the same amount of risk.

On the other hand, the option contract buyer has the right but not the obligation to buy (or sell) the underlying asset. Hence the term "option" and this option comes at a price in the form of a premium (more specifically, the time value of the premium). With this "option", the option buyer's risk is limited to the premium paid but his potential profit is unlimited.

Sellers of options take on an additional volatility risk in exchange for the premium. However, their potential profit is then capped while their potential losses has no limit. Hence, this premium can be high if the underlying asset is perceived to be very volatile.


Nov 11th, 2014

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