The holder of a derivative contract does not own the underlying asset but has the right to ownership or to deal in the asset at some predetermined date (i.e the futures market: an agreement to buy or sell a standard quantity of a specific asset at a future date). Most derivative contracts are cash settled as opposed to the physical delivery of the asset.
- Futures: A future is the right to buy or sell an asset at a specified price on a specific future date (normally quarterly). The future has to be concluded on this date. The risk is that any movement, up or down, in the price of the asset will result in either you being paid, or having to pay in, on what is called the margin. Futures, therefore, have a higher risk, but are cheaper than options.
- Options: An option is the right to buy (call option) or sell (put option) a certain number of assets at a specified price (the strike price) at a future date. The difference between a future and an option is that you pay upfront for an option and no margin call is made. An option does not need to be exercised. If, at the future date, the price of the asset is not profitable then you do not need to exercise the option and your only loss will be the initial option price you paid for it.