Trading options on futures contracts

Futures contracts apply to a variety of financial products, from stock indexes to precious metals. Trading options based on futures means buying or selling call or put options based on the direction you think the underlying product will move.

Buying options provides a way to profit from changes in futures contracts, but the cost is only a small part of the actual futures purchase. If you expect future value to increase, buy a call option. If you expect future value to fall, please buy put options. The cost of buying options is a premium. Traders also write options.

Key points

  • Futures options work similarly to options on other securities (such as stocks), but they are often settled in cash and European style, meaning there is no early exercise.
  • Futures options can be considered as a kind of “second-order derivatives”, requiring traders to pay attention to details.
  • The key details of futures options are the contract specifications of the option contract and the underlying futures contract.

Futures options

Many futures contracts have options attached to them. For example, gold options are based on the price of gold futures (called the underlying), both of which are cleared through the Chicago Mercantile Exchange (CME) group. The purchase of futures requires an initial margin of US$8,350-this amount is set by the CME and varies with the futures contract-which can control 100 ounces of gold.For example, to buy a $2 gold option only costs $2 x 100 ounces = $200, which is called a premium (plus commission). The content of option premiums and options control varies from option to option, but the cost of an option position is almost always lower than an equivalent futures position.

If you think the price of the underlying material will rise, please buy a call option. If the underlying price rises before the option expires, the value of your option will rise. If the value does not increase, you will lose the premium paid for the option.

If you think the underlying asset will decrease, please buy a put option. If the value of the underlying material decreases before your option expires, the value of your option will increase. If the underlying security does not fall, you will lose the premium paid for the option.

Option prices are also based on “Greek”, which are variables that affect option prices. Greek is a set of risk measures that indicate the degree of exposure of options to the decay of time value.

Options are bought and sold before expiration to lock in profits or reduce losses below the premium paid.

Income writing options

When someone buys an option, other people must write the option. The author of the option, which can be anyone, obtains a premium (income) from the buyer in advance, but is then obliged to pay the proceeds obtained by the buyer of the option. The profit of the option seller is limited to the premium received, but because the buyer of the option expects the value of the option to increase, it is very liable. Therefore, option authors usually own the underlying futures contract on which they write options. This hedges the potential loss of selling the option, and the seller pockets the premium. This process is called “guaranteed call options” and is a way for traders to use options to generate trading income on the futures already in their portfolio.

Written options can be closed at any time to lock in a portion of the premium or limit losses.

Trading options requirements

To trade options, you need a margin-approved brokerage account for options and futures trading.Futures quote options are available from CME Group (CME) and Chicago Board Options Exchange (Chicago Board Options Exchange), options and futures transactions are carried out here. You can also find quotes in the trading platform provided by the option broker.

Bottom line

The purchase of futures options may have certain advantages over the purchase of ordinary futures. The option seller receives the premium in advance, but is responsible for the buyer’s income; therefore, the option seller usually has the underlying futures contract to hedge this risk. Buying or selling options requires a margin-approved brokerage account with access to CME and/or CBOE products.

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