A futures contract represents an agreement to buy or sell a financial product or commodity at a given price at a specified day in the future. The owner of an option has the choice to buy or sell a financial product or commodity at a given price at a specified date in the future if it would be advantageous for them to do so. The key difference between futures and options is that futures represent an obligation, whereas options represent a choice.

Both futures and options can be extremely difficult to properly value and can result in large losses for an investor; therefore, they are not always appropriate for the average individual. However, this type of investment is hardly obscure; in fact, many investors come across the equivalent of futures and options in their everyday lives, often without realizing it.
In Pictures: 10 Options Strategies To Know

Floating Interest Rates
Perhaps the most common occurrence of futures and options in everyday financial life has to do with interest rates. When an individual takes out a floating rate loan, he or she is effectively purchasing an options contract on the future course of interest rates. If rates rise sharply in the future, the individual is on the hook to pay that higher rate. If, on the other hand, rates decline in the future, the individual can benefit from paying a lower rate. The individual also has the option of locking in the loan at a fixed rate at the time of their choosing. Practically speaking, this means that the individual would lock the rate on the loan if they anticipated an increase in interest rates. In this way, a floating rate loan is like an option, where the individual has the right, but not the obligation, to fix the rate of interest if it is advantageous for them to do so.

Of course, a lender is never going to give you something for nothing. Just as the purchaser of an option would have to pay a premium in order to have the right to buy or sell in the future, so too the holder of a floating rate loan has to pay for the right to fix the interest rate at a time of their choosing. This price will often be in the form of a slightly above-market interest rate, upfront fees on the loan, or lock-out periods during which the loan cannot be converted to a fixed rate. (For more on floating-rate mortgages, see Mortgages: Fixed Rate Vs. Adjustable Rate.)

An auction is another real-world example of futures and options contracts. This category has grown in prominence with the surge of popularity of EBay and other auction streams. The seller of an item on EBay has essentially sold a futures contract - he or she has agreed to sell a specified good at a specified time in the future. Nevertheless, as long as the final price meets the minimum bid, the seller is legally obligated to deliver the good as promised.

The bidder on EBay is essentially long a futures contract: he or she is obligated to buy a specified good at a specified date in the future. Unlike the seller, the bidder usually knows in advance what price he or she will pay, but is also legally obligated to complete the contract.

Betting on the Future Price of Consumer Goods
Another example of real-life futures is the behavior of shoppers during a sale. Consider Black Friday, the traditional start of the holiday shopping season. Shoppers flock to stores to take advantage of sale prices. In purchasing so far in advance of Christmas, the shoppers seldom stop to consider that they are essentially wagering that prices will not fall further before Christmas. This behavior is somewhat similar to buying a call option in the financial markets, although it is a safe bet that very few Black Friday shoppers think of it that way! (For more insight, see What is Black Friday?)

The purpose of this demonstration is not to persuade consumers to pull out a financial calculator or spreadsheet prior to heading to the mall. Rather, by recognizing the similarities between the financial markets and everyday financial transactions, consumers can better consider the true costs and benefits of these transactions. In the long run, this can help place consumers on better financial footing and, in this economy, that's definitely something worth working towards.

Related Articles
  1. Options & Futures

    What Does Quadruple Witching Mean?

    In a financial context, quadruple witching refers to the day on which contracts for stock index futures, index options, and single stock futures expire.
  2. Options & Futures

    4 Equity Derivatives And How They Work

    Equity derivatives offer retail investors opportunities to benefit from an underlying security without owning the security itself.
  3. Options & Futures

    Five Advantages of Futures Over Options

    Futures have a number of advantages over options such as fixed upfront trading costs, lack of time decay and liquidity.
  4. Term

    What is Pegging?

    Pegging refers to the practice of fixing one country's currency to that of another country. It also describes a practice in which investors avoid purchasing security shares underlying a put option.
  5. Home & Auto

    Understanding Pre-Qualification Vs. Pre-Approval

    Contrary to popular belief, being pre-qualified for a mortgage doesn’t mean you’re pre-approved for a home loan.
  6. Investing Basics

    An Introduction To Structured Products

    Structured products take a traditional security and replace its usual payment features with a non-traditional payoff.
  7. Options & Futures

    Contango Versus Normal Backwardation

    It’s important for both hedgers and speculators to know whether the commodity futures markets are in contango or normal backwardation.
  8. Trading Strategies

    Why Is Short Selling Legal? A Brief History

    In the U.S., before a short sale can occur, broker/dealers must have reasonable grounds to believe that shares can be borrowed and delivered on time.
  9. Investing Basics

    What Does Contango Mean?

    Contango​ is when the futures price of a commodity is higher than the expected future spot price.
  10. Options & Futures

    The Short Guide To Insure Stock Market Losses

    The best ways to hedge against losses are to diversify your portfolio and to use a variety of options.
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  3. Do hedge funds invest in commodities?

    There are several hedge funds that invest in commodities. Many hedge funds have broad macroeconomic strategies and invest ... Read Full Answer >>
  4. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  5. Can mutual funds invest in options and futures? (RYMBX, GATEX)

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  6. How do futures contracts roll over?

    Traders roll over futures contracts to switch from the front month contract that is close to expiration to another contract ... Read Full Answer >>
Hot Definitions
  1. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  2. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  3. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  4. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  5. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  6. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center