Difference between cash future and options trading
You will likely just offset your position by buying back if you sold first or selling back if you bought the contract first. Your broker has all your positions monitored on a risk server and will know anytime you get close to a delivery situation. As time draws near to a First Notice Day delivery situation and you still have an open position your broker will notify you and ask your intentions.
Brokers are responsible for any losses or fees you might cost the clearing firm where you have your account. These losses come out of his pocket, not the brokerage firm. There are some Commodity Futures contracts that do not have a physical delivery.
These contracts are settled in cash. If a Commodity cannot be stored for a long period of time due to spoilage or other logistics the contract resorts to a cash settlement. Currently there are two Commodities and a Sector that have cash settlement. From its birth a pig takes about 6 months to reach slaughter weight of pounds. When a hog weighs pounds live weight it will yield about pounds of lean pork.
The Commercial traders found it was better to hedge this widely used portion of the hog instead of the entire live hog. Since this lean hog meat cannot be stored indefinitely the exchanges created a cash settlement.
Live Cattle are calves to the point when they are about pounds which takes about months from birth. After they reach this weight they are transferred to feedlots where they become known as Feeder Cattle. Here they will remain for about 5 more months until they put on approximately more pounds.
At this point they are usually slaughtered and sent to meat processors for packaging. Leaving the feed lot the average slaughter weight is about 1, pounds. Once Feeder Cattle leave the feedlot there is a storage issue with this Commodity. For this reason the exchange uses a cash settlement process. So now you know which markets are cash settled. But just what does cash settled mean?
Leverage is when you effectively multiply the power of the cash you are investing to generate larger returns; this is possible with both options and futures and is the main reason why they are known as leverage derivatives. The fundamental difference between options and futures is in the obligations of the parties involved.
The holder of an options contract has the right to buy the underlying asset at a fixed price, but not the obligation. The writer, or seller, of the contract is obligated to sell the holder the underlying security or buy it , if the holder does choose to exercise their option. This obviously puts the holder of a contract at an advantage, because if the underlying security moves against them, they can simply let the contract expire and not incur any losses over and above the original cost.
If the underlying security moves in the right direction for the holder and therefore against the writer , then the writer must honor their obligation. In a futures contract, both parties are obliged to fulfill the terms of the contract at the point of expiration. This is a very significant difference. Buying a futures contract where you will be obliged to buy a particular security at a fixed price carries much more risk than buying an options contract where you have the right to buy a particular security at a fixed price, but are not obliged to go through with it if that security fails to move up in value as you expect.
Both parties involved in a futures contract are effectively exposed to unlimited liability. The costs involved are also different. When an options contract is first written, the writer of it sells it to the buyer and receives the money that the buyer pays.
Depending on the terms of the contract, the underlying security involved, and the circumstances of the writer, the writer may have to have a certain amount of margin on hand. They may also be required to top up that margin if the underlying security moves against them. However, the buyer owns those contracts outright and no further funds will be required from them. With futures, though, as both parties are exposed to losses depending on which way the price of the underlying security moves, they are both required to have a certain amount of margin on hand.
Price differences on futures are settled daily, and either party could be subject to a margin call if the value of the underlying security has moved against them.
Can I square up my position? When am I required to pay initial margin to my broker? Do I have to pay mark-to-market margin? What are the profits and losses in case of a Stock Futures position? What is the market lot for Stock Futures? Why are the market lots different for different stocks? What are the different contract months available for trading?