How do futures contracts differ from option contracts?

Futures contracts are unique financial instruments that involve a commitment to buy or sell an asset at a predetermined price on a specified future date. The mandatory nature of delivery in futures contracts means that both parties involved in the agreement are obligated to fulfill the terms of the contract at expiration, making it a binding commitment. This characteristic is foundational to futures trading and sets it apart from other derivatives, such as options.

In contrast, options contracts provide the buyer the right, but not the obligation, to purchase or sell an asset at a set price before or at expiration. If an options holder decides to exercise this right, they can choose whether to do so or not, meaning that there is no mandatory obligation for them to complete the transaction.

Understanding this distinction is critical when considering investment strategies. Futures are often used for hedging or speculation, with the certainty of delivery being integral to their function, whereas options provide flexibility and a way to manage risk without the commitment of delivery.