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How does an option differ from a futures contract?
AAn option pays interest while it is held
BAn option obliges the holder to trade at maturity
CAn option can never be sold before it expires
DAn option entitles but does not oblige the holder
Answer & Solution
Correct answer: D. An option entitles but does not oblige the holder
1. Futures contracts are legally binding obligations to buy or sell specified quantities of commodities or financial instruments at an agreed price at a future date.
2. Options entitle holders to buy or sell specified quantities at a set price during a specified time.
3. Unlike futures contracts, options do not legally obligate the holder to buy or sell.
4. The price paid for an option is also the maximum amount that can be lost, which caps the downside.
5. With both instruments the investor must correctly guess future price movements to earn a positive return.
6. Futures contracts pay no interest or dividends, and options have very short maturities, so it is easy to lose money quickly in either.
_Source: OpenStax Introduction to Business (CC BY 4.0), Ch 16 "Understanding Financial Management and Securities Markets", section 16.6 Securities Markets_
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