Trading Options on Futures Contracts

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Trading Options on Futures Contracts

Futures contracts are accessible for a wide range of financial instruments, including equities indices and precious metals. Trading futures options entails purchasing or selling call or put options based on the direction you expect an underlying product will move.

Purchasing alternatives offers a means to benefit from futures contract movement at a fraction of the expense of purchasing the underlying future. If you believe the value of a futures contract will rise, buy a call. If you believe the value of a futures contract will decline, buy a put. The premium is the cost of purchasing the option. Option writers are also traders.

Key Takeaways

  • Futures options function similarly to options on other instruments (such as stocks), although they are often cash-settled and of the European kind, implying no early exercise.
  • Futures options are a kind of “second derivative” that require the trader to pay close attention to detail.
  • The contract parameters for both the option contract and the underlying futures contract are the most important elements for options on futures.

Options on Futures

Many futures contracts are accompanied with options. Gold options, for example, are dependent on the price of gold futures (referred to as the underlying), which are both cleared by the Chicago Mercantile Exchange (CME) Group. To purchase the future, an initial margin of $8,350 is required; this amount is defined by the CME and varies per futures contract—which grants ownership of 100 ounces of gold.

Purchasing a $2 gold option, for example, costs just $2 x 100 ounces = $200, which is referred to as the premium (plus commissions).The premium and what the option controls vary depending on the option, although an option position is nearly always less expensive than an identical futures position.

  Sector Rotation Definition

If you feel the underlying’s price will rise, buy a call option. If the underlying price rises before the option expires, the value of your option will climb as well. If the value does not rise, you forfeit the option premium.

Purchase a put option if you anticipate the underlying will fall in value. If the underlying falls in value before your option expires, the value of your option will rise. If the underlying does not fall, you forfeit the option premium.

Option pricing are also dependent on “Greeks,” which are factors that impact the option’s price. Greeks are risk measurements that reflect how vulnerable an option is to time-value degradation.

Before expiry, options are purchased and sold to lock in a profit or decrease a loss to less than the premium paid.

Writing Options for Income

Someone else had to write the option when someone bought it. The writer of the option, who may be anybody, gets the premium from the buyer upfront (revenue), but is then obligated to reimburse the buyer’s profits.

The option writer’s profit is restricted to the premium collected, but liability is high since the option buyer expects the option’s value to rise. As a result, option writers often hold the underlying futures contracts on which they write options. This protects the writer from the possible loss of writing the option, and the writer keeps the premium. This is known as “covered call writing,” and it allows a trader to create trading profits by utilizing options on futures she already owns.

  Trading Account

To lock in a part of the premium or minimize a loss, a written option may be closed out at any moment.

Trading Options Requirements

To trade options, you must have a margin-approved brokerage account that allows you to trade options and futures. Quotes for options on futures are accessible from the CME (CME) and the Chicago Board Options Exchange (CBOE), which trade options and futures. Quotes are also available on the trading platforms supplied by options brokers.

The Bottom Line

Purchasing futures options may provide benefits over purchasing conventional futures. Because the option writer obtains the premium up front but is accountable for the buyer’s profits, option writers often purchase the underlying futures contract to mitigate this risk. A margin-approved brokerage account with access to CME or CBOE products is required to purchase or write options.

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