An option is a derivative contract giving the holder (buyer) the right, without the obligation, to trade (buy or sell) a specific underlying asset at or by a preset expiration date. The underlying asset could be a commodity or share of stock, or a variable such as an interest rate or energy cost at a preset level (strike price) on or up to a prespecified date (expiration date).

On the other hand, a forward contract (or simply, a forward) is a derivative contract which involves an agreement between two parties to the effect that the holder (buyer or long) agrees to buy an asset from the seller at a prespecified delivery date in the future for a preset delivery price.

Options differ from forward contracts in many aspects including cost, payoff profile, risk profile, and contracting obligation. An option contract entails that the buyer pays the writer (seller) an upfront premium. In a forward contract, no upfront payment has to be made. Additionally, the holder of the forward is obligated to buy the underlying asset at a preset price and at a preset date in the future. The prespecified price of a forward contract is determined in such a way that the price of the forward is zero at contract date. Hence, the expected fair value of the asset at a given maturity date is often known as the forward value (of the underlying).

The payoff profile of an option limits losses to the holders to the price paid for the option (the premium). In forward contracts, losses to the seller may be unlimited depending on how far market prices would go beyond the strike price, while losses to the buyer are limited to the strike price (which would occur should the market price drop to zero). In terms of obligation, the buyer of an option has the right but not the obligation to enter into a contract. The option writer (seller) is obligated to transact if requested by the buyer to do so. In contrast, both parties to a forward contract are obligated to perform the contract.

The holder of an option may receive a payout at maturity which is larger than zero, while the maximum loss is equal to the premium paid for the option. For a forward contract, the maximum loss on one contract is equal to the strike price of the forward, which arises if the underlying price drops to zero. And as the contract is worth zero at contract date, the strike price of the forward, in this case, is equal to the forward value. In this sense, a forward contract is a zero sum game (one party gains at the expense of the other). The same applies to options but just depending on the state of market price with respect to the strike price, and with minor twists. For a call option, if the market price is above the strike price, the more the difference between the two prices the higher the gains of the buyer and also the higher the losses of the seller. If the market price is below or equal to the strike price, the seller gains, and the buyer loses, the premium (as exercising the option would be pointless in such a case).