Futures options are considered a low-risk way to trade futures markets. Many new traders start with trading futures options instead of direct futures. There are fewer risks and volatility when buying options compared to direct futures. Many professional traders only trade options. Before you can trade futures options, it is essential to understand the basics.
Futures Options
An option is the right, but not the obligation, to buy or sell a futures contract at a specified strike price for a certain period of time. Buying options allows a trader to speculate on changes in the price of a futures contract. This is done by purchasing calls or puts.
Key Terms
Premium: The price paid by the buyer and received by the seller when purchasing an option is the premium. Options are price insurance. The lower the probability that an option will occur at the strike price, the less it costs in absolute terms; the higher the probability that an option will occur at the strike price, the more expensive these derivatives become.
Contract Months (Time): All options have an expiration date; they are only valid for a certain period. Options are wasting assets; they do not last forever. For example, a corn option expires in December at the end of November. As assets with a limited timeframe, attention must be paid to option positions. The longer the option, the more it costs. The time value of the premium for the option is its time value.
Strike Price: This is the price at which you can buy or sell the underlying futures contract. The strike price is the price of insurance. Think of it this way: the difference between the current market price and the strike price is akin to the discount in other forms of insurance. For example, a corn option with a strike price of $3.50 in December allows you to buy a December futures contract at $3.50 at any time before the option expires. Most traders do not convert options into futures positions; they close the option position before expiration.
Buying an Option
If you expect the futures price of gold to rise in the next 3 to 6 months, you will likely buy a call option.
Buying 1 December gold option at $1400 for $15: 1: Number of option contracts purchased (representing 1 futures contract for gold weighing 100 ounces) December: Option contract month 1400: Strike price gold: Underlying futures contract buy: Type of option 15: Premium ($1500 is the price to buy this option, or 100 ounces of gold × $15 = $1500)
Buying an option is equivalent to buying insurance that the price of the asset will rise. Buying a put option is equivalent to buying insurance that the price of the asset will fall. Buyers of options are insurance buyers.
When buying an option, risks are limited to the premium you pay. Selling an option is akin to acting as an insurance company. When you sell an option, you can only earn the premium you receive upfront. The potential for losses is unlimited. The best hedge for an option is another option on the same asset, as options behave similarly over time.
The Importance of Volatility
The main factor for option premiums is “implied volatility” or the market perception of future variability of the underlying asset. Historical volatility, on the other hand, is the actual historical variance of the underlying asset in the past.
Frequently Asked Questions (FAQs)
How do you trade futures options?
To trade futures or options on futures, you will need access to the futures market through a brokerage account. Not all stock brokers provide access to the futures market, so you should ensure to open an account with a firm that meets your needs. Futures accounts may have higher capital requirements.
What
What are stock futures?
“Stock futures” refers to futures contracts that track stock indices. For example, the “ES” futures contracts track the S&P 500 index. The “YM” contracts track the Dow Jones Industrial Average. In addition to stock indices, traders can also use futures contracts to speculate on interest rates, commodities, currencies, and even weather events.
How can you hedge futures positions with options?
Hedging is a strategy that involves taking a small opposing position to the larger position you hold. The idea is to use the small position to protect your larger position. Either your small position is profitable—offsetting some loss in the larger position—or your small position loses value while your larger position continues to gain.
Options work well for this purpose, as they allow you to express specific views on the direction and speed of price movement. For example, if you have ES contracts that will expire in six months, but you believe that ES will lose value in the coming month, you can buy a put option or sell a call option to provide some downside protection without touching your original ES position.
Source: https://www.thebalancemoney.com/futures-options-the-basics-809147
Leave a Reply