Merits of Options and Futures to Hedgers
The most frequently used hedging tools nowadays are options and futures. These two derivative instruments are utilized by hedgers in order to insure the profit in future, of to hedge the possible financial risk. Even though in some cases futures and options may result in a financial loss, they are still considered powerful tools to ensure the invariability of the asset price. 
Assume Mr. Berg is an experienced potter (and as later turns out financier). He wants to make sure that no matter what the situation on the cups market would be, he would still make profit. He knows that in a months time the price for clay would decrease, therefore the supply should increase. As a result, the price for cups on the market would decrease. Due to high competition, and aggressive competitors, Mr. Berg decides to hedge risks, and closes a future contract with Biggles Company, obliging to sell 100 cups in a month. This company wants to boost their sales using sales promotion strategy, and add a free cup to their vacuum flasks. Current market price for cups is 10, while contract price is 9. After a month, due to decline of price of clay, market price for cups was 8. This way, Mr. Berg sold 100 cups to Biggles at the contract price of 9, which gave him a profit of 100. The potter this way hedged risk of selling cups at too a low price. 
On the financial level, however, a future is an agreement between two parties (buyer and seller) that obliges them to make a sale of a certain quantity of commodity or a certain product of a certain quality on a specific date at a definite price. The benefit of this derivative instrument is evident, especially if the market price of the underlying market is constantly changing. Hedgers use this derivative instrument to insure their future profit. The factors that make this derivative a profitable hedging tool are the contract price of the underlying asset and the market price if this asset at the date set by contractors. If the market price of the underlying commodity is greater than the contract price on the closeout date, then the buyer benefits from the future. On the other hand, as seen from the example with Mr. Berg and Biggles Company, if the contract price is greater than market price on the closeout date the seller benefits from the future. 
Let us look at another example how hedgers can wisely and productively apply futures. Let’s suppose that Mrs. Paulson, a grocer, is running out of cabbage. She can go and purchase a thousand of cabbages now at market price of 20 (assuming they weigh equally thereafter). She knows that basing on her selling statistics, she will run of cabbages in two months. She understands that market price may drop too low, so she decides to close a contract with Mr. Witman, agreeing to buy a thousand of commodity for 15. Mr. Witman, in turn, agrees to deliver the thousand of cabbages to her because he understands that in two months the demand for vegetable would drop immensely. After two months, Mrs. Paulson made a profit of thousand having bought a thousand of cabbages from Mr. Paulson at contract price. However, if she had not made this future with Witman, she would then have had to buy cabbages at 16 per unit. 
As we see from the two examples, both sides of the future contract may either benefit or suffer. But if the hedger is an experienced and intelligent financier, he/she would consider the change of the market value of the commodity and decide the contract price of the future. There are, of course, many cases and industries where the future market price for a particular product cannot be determined. The major factors in ability or inability to predict the change depend on the liquidity and the randomness of the market price of an asset, and also on the information the hedger possesses.
This way, it becomes evident that futures can be easily (or in some cases not very easily) unitized in order insure future profits, and to hedge certain financials risks. Of course, vast majority of future contracts is much more sophisticated than the two examples above, but the structure and the mechanisms are the same. 
Options are another derivative instruments financiers use to hedge risks. Even though from the first glance the difference between these two derivatives may be obscured, they possess different features and completely different structure. Options are much more sophisticated than futures. The main differences between options and futures consist in the following: options, as opposed to futures, are bought, and options contracts do not obligate holders to buy or sell, they just grant a right. By definition, an option is a contract that gives a right, but does not oblige, the holder to buy or sell a certain product (or a certain amount of commodity) at a certain price within a certain period of time or on a specific date. The grantor of the option, however, is obliged to honor the contract if the holder decides to exercise it. The right to buy underlying assets is called the call option. While the right to sell an asset is called the put option. The party or the person granting the option is the option writer. The price for which the option was bought from the writer is called the premium price, while the contract price at which the writer sells or buys the underlying asset is called the strike price. Now let us take a deeper look at the mechanisms of options.
If a hedger makes an agreement to with the option writer to have a right to purchase certain underlying asset, he/she then pays the premium to hedge future financial risks. This premium price, be it low or high, is the maximum loss the option holder would suffer in case of misfortune. This misfortune is the case when the market price of the underlying commodity is greater than the strike price. In such case the holder can simply buy the asset on the market. However, if the price of that commodity is higher than the strike price, this does not necessarily mean that the holder will exercise the option and make a profit. Only if the market price of the asset is greater than the strike price plus premium will the holder exercise the option. In other words, if in a call option premium is 5 and strike price is 100, the holder will a) suffer a loss equal of 5 (premium) if the market price is higher than strike price and does not exercise the option, b) neither loses nor makes anything at break-even if the market price is 105 (strike price plus premium) and exercises the option, and c) makes a profit of P when the market price is greater than 105 (and equal to 105+P) and exercises the option. For the writer of the same call option, the distribution of profit/loss is opposite. If the market price drops below strike price, the writer makes profit equal to 5, with no exercise by the holder. In case the market price is 105, the break-even occurs for both the holder and the writer. Provided the market price for the underlying product is greater than 105, the writer will suffer a loss (in case the holder exercises the option). From the moment when the contract is closed until the moment when the option is exercised or expired the holder of a call option is long on a call option, while the writer is short on the call option.
With put options, or the option that grants a right to sell an asset, the distribution of profit/loss and holder/writer is reversed. If the market price for underlying commodity is less than strike price plus premium, the holder exercises the option and gains profit, while the writer suffers a loss having sold the asset at a higher price. In case the market price is equal to strike price plus premium, both parties are at break-even. Should the market price rise above the strike price plus premium price, the holder does not exercise the option and suffers a loss equal to prepaid premium, while the writer keeps the premium. 
If a company director gives his deputy (and friend), for a price, a right to buy director’s share of the company in five years at a certain price, the deputy will then be called option holder. He/she will try to do his/her best to improve company’s performance so that price of the share grows above the strike price. This is a simple example of how options can be used in real business life.
Having discussed options and futures, we can see that both of the derivatives can be utilized wisely in order to hedge financial risks. Possessing different properties and profit/loss structure, options and futures provide many possibilities to insure the party’s profit and exercise intelligent financial activity. Futures and options help financiers not only hedge risks, but also make money. However, one should not relax while applying options and futures, because either side of these contracts may suffer a loss.
Bibliography
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