The price of a stock can change daily. To protect against price fluctuations, stock traders can purchase options or futures. Both options and futures allow a trader to buy or sell stock at a predetermined price in the future. However, while a trader must exercise a future, he can choose not to exercise an option.
An option is a contract that allows the holder to either buy or sell stock on a predetermined date for a specific price. Options contracts that allow the holder to buy a stock are "calls," while contracts that allow him to sell a stock are "puts." To purchase an option, a stock trader must pay a nonrefundable premium. When the option matures, the holder can decide whether to act on it. If he chooses not to act on it, the contract becomes void and he forfeits his premium.
A future is a contract that requires the holder to purchase stock on a certain date for a specific price. To purchase a future, a stock trader pays a down payment on the stock he will purchase later. When the future matures, the holder must pay the remainder of the cost of the stock, regardless of the market price.
While a stockholder can purchase an option to either buy or sell stock, he can only use a future to purchase stock. A call option gives the holder the right to purchase a stock for a certain price, but a futures contract requires him to do so. While stock traders must pay a premium on top of the price of the stock to purchase a call option, no such premium is necessary to purchase a future.
Though futures don't require a premium, they typically pose a greater risk of loss than options do. If the price of a stock falls below the price listed on a call option, the holder of the option can let it expire and purchase the stock at the lower price. However, if the price of a stock falls below the price listed on a future, the holder of the future must purchase the stock at the higher price anyway.
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