What are futures and options?

Useful Resources

Guide to Index Futures

Futures

Futures are financial contracts that let people lock in a price today for something that will settle in the future. They are widely used around the world to manage risk.

The contract is standardised and, at expiry, it is either:

Physically delivered (the asset changes hands), or
Cash settled (the difference in value is paid in cash).

Example

Imagine Jane is keen on purchasing a property but does not want to take possession of the property today.

Jane agrees now to buy a house in 6 months
Price is fixed today at $700,000
Jane pays a deposit

No matter what happens to house prices, the deal must go ahead at the agreed price.

Physical delivery vs cash settlement

Physical delivery

The actual asset is exchanged at expiry
The buyer receives the product
The seller delivers the product

If Jane’s house contract was physically settled, she would receive the house and pay the agreed price.

Cash settlement

No asset is delivered
Only the difference in value is paid in cash at expiry

If Jane’s house contract was cash settled:

Jane agrees to buy the house for $700,000
On settlement, the house is valued at $730,000 → Jane receives $30,000 in cash
If it is valued at $670,000 → Jane pays $30,000 in cash

Why use derivatives?

Price certainty

Derivatives let you lock in a price today for something that happens in the future.
This gives certainty, even if market prices move.

Manage risk (hedging)

If prices move against you in the real world, a gain on the derivative can offset that loss.
This helps to manage costs and protect margins

Flexibility

Futures lock in a price and must be settled
Options give you choice — you can use them if prices move in your favour, or let them expire

Frequently Asked Questions

What is a derivative?

A derivative is a financial contract whose value is based on something else, such as a share price, an index, or a commodity price.

Do I need to pay the full contract value upfront?

No. Participants post a margin, which is a deposit to cover potential losses. Profits and losses are settled daily. Each day, the contract is marked to market, the exchange calculates the change in value based on that day’s settlement price, and any profit or loss is credited to or debited from the participant’s margin account in cash.

Can I exit a futures position before expiry?

Yes. Most contracts are bought and sold before expiry rather than held to settlement, because most traders want price exposure rather than settlement or delivery.

What is an underlying asset?

The underlying asset is the thing the contract is based on, such as a share, an index, or a commodity.

Who guarantees the trade?

Exchange traded derivatives are cleared through a central clearing house, which reduces the risk of the other party failing to meet their obligations.

Why are derivatives traded on an exchange?

Trading on an exchange provides:
- transparency
- standardised contracts
- clearing through a central counterparty

Options

Imagine Jane likes a property but isn’t sure she wants to buy it yet and doesn’t want to miss out.

Jane pays the seller a non‑refundable fee (premium)
This gives Jane the right, but not the obligation, to buy the property
The purchase price is fixed today at $700,000
The option lasts for 6 months

Jane can choose whether or not to buy the property.

If Jane buys the property → she pays $700,000
If Jane decides not to buy → the option expires and Jane only loses the premium paid

American vs European style options

American‑style option

Can be exercised at any time before expiry
Jane can buy the property whenever she chooses in the 6‑month period

European‑style option

Can only be exercised on the expiry date
Jane must wait until the end of the 6 months to decide

Key difference from exchange‑traded derivatives

These examples involve two parties directly
In exchange‑traded options, contracts are cleared through a central clearing house, which sits between buyers and sellers and manages risk