The Difference between Futures and Options in Commodity Markets
There’s a big difference between futures and options. Often folks think of futures and options as being one and the same in the commodities markets — that’s understandable, because whenever you hear “futures,” “options” is never too far behind! However, futures and options are different financial instruments with singular structures and uses. Realizing this difference right off the bat will help you understand these financial instruments better.
Futures give the holder (buyer) and underwriter (seller) both the right and the obligation to fulfill the contract’s obligations. Options give the holder the right (or option) but not the obligation to exercise the contract. The underwriter of the option, on the other hand, is required to fulfill the contract’s obligations if the holder chooses to exercise the contract.
When you’re buying an option, you’re essentially paying for the right to buy or sell an underlying security at a specific point in time at an agreed-upon price. The price you pay for the right to exercise that option is known as the premium.
The technically correct way of thinking about options is as “options on futures contracts.” In other words, the options contracts give you the option to buy futures contracts for commodities such as wheat and zinc. These options are different than stock options, which give you the option to purchase stocks.