When you buy an option, you purchase
the right to buy or sell a specific quantity of the underlying
investment at a set price, within a particular timeframe.
Unlike a futures contract, you're not obliged to buy or
sell — you simply lose the amount you paid for the
option. But if your analysis of the direction of the market
is correct, you stand to make a profit.
When you sell an option, you must fulfill your obligation
to buy or sell the underlying investment at an agreed upon
price, if the buyer exercises
the option. The biggest risk occurs if you sell an
option on an underlying investment that you don't own.
That means you'd have to buy it at a market price to meet
your obligation to sell, which could cost you a bundle.
More conservative investors may buy or sell options to
help protect the value of their portfolios from falling
prices, to lock in a favorable purchase price, or to make
some immediate income. Speculative traders like the leverage,
or opportunity to have a potentially larger gain than they
could achieve by owning the underlying investment. Of course,
they could have larger losses too, but that's the risk
they're willing to take.
Futures
When you buy or sell a futures contract, you're making
an agreement to buy or sell a product at an agreed-upon
price by a specific date in the future. Since product prices
can change in the meantime, you stand to gain or lose money
on the deal. But what most investors do instead is buy
an offsetting contract — for example, one that obliges
them to sell if their original contract obliged them to
buy, hoping to make money on the changing value of the
contract.
Professor
Roger Ibbotson, Yale University, chairman and founder
of Ibbotson Associates
Professor
Roger Ibbotson, Yale University, chairman and founder
of Ibbotson Associates 
