Futures vs. Options: Which One Suits You Best?
Trading in the financial markets can be an exciting and rewarding experience. With many available options, deciding which route to take can be challenging. Futures and options contracts are investment options with the potential to generate leveraged returns. Both are derivatives — financial instruments that derive their value from an underlying asset such as a stock, commodity or cryptocurrency. However, these two financial tools differ significantly and cater to different types of investors. So, which of them is the best for your investment goals?
In this article, we'll break down the differences between futures and options contracts to help you determine which is right for you. So buckle up and get ready to unlock the potential of these powerful financial instruments.
What Are Crypto Futures Contracts?
Crypto futures contracts are agreements between two parties to buy or sell an underlying asset at a predetermined price and specific date in the future. Futures contracts allow investors to trade cryptocurrency without actually owning them.
Crypto futures contracts share similarities to traditional futures contracts but use cryptocurrency as the underlying asset. But unlike their conventional counterparts, crypto futures are characterized by high volatility, leverage and 24/7 trading.
Crypto futures offer investors the potential to profit from rising and falling markets, making them an attractive investment opportunity for those who have a good understanding of the crypto market and are comfortable with the added risk.
Traders can take a long or short position, depending on their outlook. Long positions are a common practice for traders who predict a price increase; however, traders short a position in the hope of benefiting from the price declines.
If the position is held until maturity, the trader will gain or lose depending on the settlement price at maturity. At maturity, the settlement price is determined by the spot price of the underlying cryptocurrency. If the trader closes the futures position before maturity, the profit or loss depends on futures market prices at the time of unwinding.
Unlike spot or cash assets, futures typically operate "on margin," allowing traders to gain exposure to larger gains with relatively small capital.
Futures margin works in two ways:
Initial Margin: It is the minimum percentage amount of cash needed to open the position.
Variation or Maintenance Margin: The amount of funds needed to maintain the initial margin based on the underlying asset's movement.
Futures are typically (but not always) contracts based on the price of an asset at a specified future date (forward contract).
Types of Crypto Futures Contracts
Standard Futures Contract
Like traditional futures contracts, standard crypto futures contracts govern trades in cryptocurrency at an agreed-upon price and predetermined date. They're similar to standard futures contracts in conventional markets with similar expiry and settlement mechanisms.
Traditionally, expiration dates occur monthly (serial) or every three months (quarterly). At the time of expiration, the position is closed via a settlement process (more on that below). For example, the CME Group launched Bitcoin futures contracts that are cash-settled every three months in USD.
When trading standard futures, you should remember this:
To maintain a long-term holding, you must "roll" the position forward before it expires.
To do this, you must close your position in the active contract (front month) and open a corresponding position in a further forward futures contract (back month)
Another thing to consider is that asset prices usually change over time. For this reason, futures contracts are priced using a forward curve.
For assets that are expected to rally over time, the price of forward contracts rises as they move further into the future (contango).
Whereas for assets expected to plunge, the price of forward contracts falls as they move further into the future (backwardation). Because of this, the prices of different maturities (expiration dates) can fluctuate dramatically, making it challenging to manage a long-term position — especially when the contract is close to expiry (run-off).
Physical Delivery Futures
Physical delivery futures are futures contracts where the underlying cryptocurrency is physically delivered to the buyer at the end of the contract. This type of contract is designed for those who want to take actual ownership of the cryptocurrency rather than just speculating on its price movements.
Perpetual Futures (Perps)
In crypto, perpetual futures contracts are linear contracts with no expiration date. Like standard futures contracts in crypto, they allow traders to take a long or short position on the price of a cryptocurrency and profit from price changes without owning the underlying asset physically. However, unlike traditional futures, perpetual futures have no expiration date.
Trading perpetual futures have two main advantages over traditional futures contracts:
Traders can maintain a long-term holding without rolling the position forward before the contract expires, reducing basis risk.
The funding mechanism ensures the futures price will stay within the spot price of the underlying asset.
For instance, the funding rates are regular payments (every 8 hours for Bybit products) provided to or by long or short traders, depending on the difference between perpetual contract markets and spot prices.
The perpetual futures funding mechanism incentivizes traders to buy futures when the price is low relative to the underlying spot market. By contrast, high funding rates incentivize traders to sell futures — this works by creating a risk-free arbitrage if the futures price deviates too far from the underlying.
For example, if the BTC funding rate is positive (longs pay to shorts), in theory, you could sell futures contracts in BTC and buy an equivalent amount of BTC in the spot market to hedge your position, at the same time collecting the funding fees. This arbitrage window ensures the futures price remains anchored to the underlying asset.
Inverse Futures
Inverse perpetual contracts allow traders to use BTC and other coins as the base currency. Since different coins can be used as collateral and the payoff, margin and P&L are calculated differently from linear perpetual futures.
Futures Contracts Settlement Types
Futures contracts are usually settled in one of two ways:
Physical Settlement — At the expiration date, you must take delivery (long position) or make delivery (short position) of the underlying asset.
Cash-Settlement — At expiry, the investor's account is debited or credited the difference between the opening price of the trade and the contract settlement price.
Note: Bybit's Perpetual Futures Contracts are cash-settled in USDT or USDC.
Trade BTCUSD Inverse Perpetual on Bybit
What Are Crypto Options Contracts?
Crypto options contracts, like crypto futures, are financial contracts tied to the value of any underlying digital asset that gives traders an option to buy or sell the asset at a set price on a future date. However, unlike crypto futures, options contract holders have the right but are not obligated, to buy or sell the underlying asset at maturity.
Crypto options contracts offer holders a way to reduce the risk of loss and avoid forced liquidations associated with futures contracts. For this feature, buyers must pay the option's writer a non-refundable initial fee or premium.
While various types of options contracts are available in the crypto market, the two common types are call and put options.
Types of Options: Call and Put Options
Call options (Calls) allow the trader to buy an underlying asset at a predetermined date and price (strike price). On the contrary, put options (Puts) benefit the buyers if the price of the underlying assets falls. Both puts and calls have a specified price (strike price) at which the holder may activate the option either before or at the contract's predetermined expiration date.
The option buyer pays a fee known as an "option premium" to the seller. The premium represents the maximum potential loss for the buyer. Whereas for the seller, the premium is the maximum potential profit.
Say, as an experienced trader, you're convinced the price of BTC will be on the uptrend and buy a call option with a strike price of $50,000. If the price of BTC goes up and reaches $60,000, you can exercise the option to buy BTC at $50,000 and then sell it at $60,000 for a profit.
Conversely, if BTC price plunges to $30,000 at the call option maturity, you can decide not to exercise your options right. But you'll have to forgo the premium.
In contrast, a put option allows the buyer to sell the asset at a predetermined price before the contract expiration.
Fearing a market downturn, you buy a put option on ETH, with a strike price of $3,000 as a hedge. If the price of ETH drops to $2,000, you can exercise your option to sell ETH at $3,000 to cut your losses.
For example:
Here are the steps needed to execute the above trade using Bybit’s USDC-settled BTC-Options.
Step 1: On your desktop, head to the official Bybit website. Under Derivatives, select USDC Options, then BTC-Options.
Source: Bybit
Step 2: Deselect the expiration dates you don’t want to view. Or you can choose to display several expiration dates at the same time.
Step 3: Next to the expiration dates, select the number of available strike prices you wish to view from the drop-down list.
Source: Bybit
Step 4: Select option type: Calls or Puts
Call options are displayed on the left-hand side of the options chain, and Put options are on the right. All expiration dates available are displayed at the top of the option chain.
Here, you can see the option’s bid-ask spread, volume, delta calculation, and your current position (assuming you have one).
Step 5: Once you’ve clicked on the strike you wish to view, an order placement window will pop up on the right side of the page. Here, you’ll find the IV, delta, theta, gamma and vega calculations for the selected strike, along with the order book depth.
You can place orders by price or by selecting your desired IV level.
To place the order:
- Select a direction: Buy or Sell
- Enter the order price, or the amount of IV
- Enter the order quantity
- Select Post-Only (optional)
- After completing these steps, click on the Place Order button.
Source: Bybit
Step 6: After you’ve placed your order, a confirmation window will appear.
Once you’ve checked that all the information you've entered is correct, click on Confirm to submit your order.
Source: Bybit
When to Use Options?
The beauty of options is that you may use them to profit from any market condition. Whether you believe the underlying asset will move up, down, or even sideways, there is an options strategy for you.
But with options, there is more than just the price movement to consider. Rather than a straightforward bet on whether the price will the price go up, down, or sideways, with options you need to ask yourself “will the price go up, down or sideways before the expiration date?”
Futures vs. Options: The Similarities
While futures and options contracts have significant differences, they also have similarities. Futures and options contracts are both derivatives that allow investors to trade an underlying asset without actually owning it. Traders can get exposed to cryptocurrencies without the hassles of buying and storing them.
Crypto investors can use futures and options contracts as hedging instruments. Hedging is a way of managing risk to minimize financial loss by opening two offsetting positions.
Furthermore, both futures and options contracts offer traders the advantage of leverage. Leveraged contracts allow traders to access the underlying asset with a smaller capital. This way, you can trade larger contracts with little funds. However, using leverage can amplify your risks.
Futures vs. Options: The Differences
Despite their similarities, futures and options contracts are fundamentally different. The most significant difference between the two is the level of obligation. Futures contracts are legally binding agreements to trade an underlying asset, and the holder must execute the contract at the agreed price and date. On the other hand, options contract holders have the right but are not obligated, to buy or sell and can decline to execute the contract if the market goes against their position.
Another key difference between the two is their risk profile. Futures contract holders may risk having their positions to be liquidated when their wallet balance falls below the margin requirements of their open position. In contrast, options contracts may have limited risk if you buy them because the buyer only has the right to purchase the underlying asset and is not obligated to do so. An option contracts holders' risk is only limited to the premium they paid for the contract regardless of the underlying asset's price movement.
Lastly, futures and options contracts have different fee structures. Options buyers must pay a premium to the seller, which is essentially a fee for the right to purchase the underlying asset at a predetermined price on or before a specified date. In contrast, no upfront fee is required to open a futures contract. Still, the exchange may charge various fees, such as trading fees and funding rates.
Who Trades Futures and Options?
Futures and options contracts are popular among a wide range of traders, including individual investors, institutions and hedge funds. Some of the most famous futures contract traders include Lee Stern, Paul Tudor Jones and George Soros.
Lee Stern is a well-known trader who began his trading career in 1947 after leaving the Air Corp. He is the longest-tenured trader at the Chicago Board of Trade and is known for his success in the commodities market. Lee Stern trades a range of products, including grains, gold, crude oil and bonds.
Paul Tudor Jones is a renowned futures trader and hedge fund manager who made his mark in the market with his successful predictions of the 1987 stock market crash. He founded the Tudor Investment Corporation in the 80s and is known for his aggressive and contrarian approach to trading and his success in the futures market.
Another famous futures trader, George Soros, is known as "The Man Who Broke the Bank of England." He made billions of dollars in the currency market by betting against the British pound and is one of the most successful traders of all time.
In the options market, notable traders include Andy Krieger, Carl Icahn and John Paulson.
Andy Krieger is widely considered one of the most successful options traders of all time. He gained fame in the late 1980s for his profitable trades in the foreign exchange market, including his successful bet against the New Zealand dollar. He is known for his unconventional and aggressive trading style, which has earned him a reputation as a skilled and daring trader.
Carl Icahn is a well-known activist investor and options trader. He is known for his focus on undervalued companies and his willingness to take large positions in those companies to push for changes that will boost their stock price. He has a long history of successfully using options trading strategies to enhance his returns.
John Paulson is another notable options trader. He is best known for his 2007 trade, where he made $15 billion by shorting the housing market. The Wall Street Journal referred to the trade as "The Greatest Trade Ever."
Should You Trade Futures or Options?
The choice between futures and options contracts depends on several factors, including risk tolerance, trading experience and investment objectives.
Risk Tolerance
Futures contracts come with a commitment to buy the underlying asset and can be subject to liquidation risks that are great compared to option contracts. Buying options have limited risks, though selling them still comes with unlimited risks.
Trading Experience
Both trading futures or options are better suited to seasoned traders who understand the profit and loss, margin requirements and associated risks. You can set up complex options strategies with limited risk if you understand the characteristics and risks of options. Trading futures contracts requires expertise in the market and a solid risk management strategy.
Investment Objectives
Futures contracts offer an intuitive way to quickly trade long and short positions on leverage and take advantage of short-term market fluctuations. If you want to amplify your returns – and risks – both futures and options can help. Options are often used for more complex strategies that factor in market volatility. They also provide a means to hedge against market volatility and manage portfolio risks.
Are Futures Better Than Options?
Whether futures are better than options depends on your financial objectives. If you're looking for simplicity, futures may be the way to go. If it's the flexibility you're after, options could be better.
Which Is Safer: Futures or Options?
Both futures and options carry risk, of course. The key difference is that you have significant risk when buying or selling futures. But with options, the buyer's risk is always limited to the premium paid.
The Bottom Line
Both futures and options contracts have their uses and benefits, and the choice between them depends on several factors, including risk tolerance, trading experience and investment objectives. Before trading either of these financial instruments, you must understand the risks involved and have a strong risk management strategy. By considering these factors and seeking the guidance of a professional, you can make an informed decision and determine which financial instrument best suits your needs.
Disclaimer: This article is for informational and educational purposes only. Investors should seek professional advice before trading or investing. Please do your own research and due diligence on all trading instruments.
