Distinction between futures and options contracts

A futures contract is a standardized agreement to buy or sell a specified quantity of an underlying asset, such as an equity index, at a pre‑determined price on a future date. In India, futures are listed on exchanges like NSE and BSE and are governed by SEBI (Securities and Exchange Board of India) regulations, which enforce daily mark‑to‑market and margin requirements.

The contract is binding for both parties: the buyer has the obligation to purchase, and the seller must deliver, irrespective of the underlying’s price at expiry. Because the contract is settled daily, gains and losses are realised each trading day, which helps the exchange manage credit risk.

For the exam, remember that futures involve obligation, not a choice. Questions often ask which party can walk away without a loss – the answer is none; both parties are locked in until the contract is closed or offset.

• Standardized size (e.g., 75 shares per lot for Nifty futures).
• Daily mark‑to‑market and margin posting.
• Physical or cash settlement as per exchange rules.

An options contract gives the holder the right, but not the obligation, to buy (call) or sell (put) the underlying asset at a specified strike price before or at expiry. In the Indian market, options are also exchange‑traded, with SEBI mandating that the option premium be paid upfront by the buyer.

The seller (writer) of an option, however, bears the obligation to fulfil the contract if the holder decides to exercise. This asymmetry creates a distinct risk profile: the buyer’s maximum loss is limited to the premium paid, while the writer’s potential loss can be unlimited for uncovered (naked) positions.

Exam takers must recognise that the presence of a premium and the right‑versus‑obligation distinction are the hallmarks of options. Questions frequently test whether a scenario describes a call or a put, or whether the party involved is a buyer or writer.

• Premium paid up‑front and non‑refundable.
• Strike price determines the exercise point.
• European vs. American style – Indian options are mostly European.

Futures require both an initial margin (a percentage of contract value, typically 5‑10% in India) and a variation margin that reflects daily price changes. The exchange monitors these margins and issues margin calls if the account balance falls below the maintenance level.

Options buyers only need to pay the premium upfront; no additional margin is required because the maximum loss is known. Writers, however, must post margin to cover potential adverse moves, especially for uncovered positions. SEBI mandates higher margins for naked writers to protect market participants.

Exam questions often present a scenario with margin percentages and ask for the amount of cash that must be deposited. Remember to calculate margin on the contract’s notional value (price × lot size) and to differentiate between buyer and writer requirements.

Market participants use futures for speculation, arbitrage, and efficient price discovery. Because futures are settled daily, they are attractive for traders who need tight leverage and want to roll positions across expiries.

Options are preferred when investors seek to protect a portfolio (protective puts) or to generate income (covered calls). The premium paid or received is a key factor in determining the cost‑benefit of the strategy, and Indian investors must consider the tax treatment of option premiums under capital gains rules.

For the NISM exam, be prepared to match a strategic objective (e.g., limit downside, enhance yield) with the appropriate derivative instrument and to identify the regulatory implications such as mandatory reporting for large positions.