Options versus Forwards

There are two key differences between an option contract and a forward contract. The first is obvious. With a forward contract, both parties are obligated to transact; one party delivers the asset, and the other party pays for it. With an option, the transaction occurs only if the owner of the option chooses to exercise it.

The second difference between an option and a forward contract is that, whereas no money changes hands when a forward contract is created, the buyer of an option contract gains a valuable right and must pay the seller for that right. The price of the option is frequently called the option premium.

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