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What Are Futures Options
By: Tom Bradley
An option on a futures contract is the right, but not the obligation, to buy or
sell a particular futures contract at a specific price on or before a certain
expiration date. There are two types of options: call options and put options.
Each offers an opportunity to take advantage of futures price moves without
actually having a futures position.
A call option gives the holder (buyer) the right to buy (go long) a futures
contract at a specific price on or before an expiration date. For example, a
June Gold 550 call option gives the holder (buyer) the right to buy or go long a
Gold futures contract at a price of 550 (short-hand for $550.00/oz.) anytime
between purchase and the June expiration. If Gold futures rise substantially
above $550.00, the call holder will still have the right to buy Gold futures at
$550.00.
The holder of a put option has the right to sell (go short) a futures contract
at a specific price on or before the expiration date. For example, an June Gold
550 put gives the put holder the right to sell June Gold futures at $550.00/oz.
Should the futures decline to $530.00/oz., the put holder still retains the
right to go short the contract at $550.00/oz.
An option buyer can choose to exercise his or her right and take a position in
the underlying futures. A call buyer can exercise the right to buy the
underlying futures and a put buyer can exercise the right to sell the underlying
futures contract. In most cases though, option buyers do not exercise their
options, but instead offset them in the market before expiration, if the options
have any value.
An option seller (i.e., someone who sells an option that he or she didn't
previously own) is also called an option writer/grantor. An option seller is
contractually obligated to take the opposite futures position if the buyer
exercises his or her right to the futures position specified in the option the
buyer has purchased. In return for the premium, the seller assumes the risk of
taking a possibly adverse futures position.
Puts and calls are separate option contracts; they are not the opposite side of
the same transaction. For every put buyer there is a put seller, and for every
call buyer there is a call seller. The option buyer pays a premium to the seller
in every transaction. The following is a list of the rights and obligations
associated with trading put and call options on futures.
Call Buyers »pay premium »have right to exercise, resulting in a long futures
position »have time working against them »have no performance bond requirements.
Call Sellers »collect premium »have obligation if assigned, resulting in a short
position in the underlying futures contract »have time working in their favor
»have performance bond requirements
Put Buyers »pay premium»have right to exercise, resulting in a short futures
position»have time working against them»have no performance bond requirements
Put Sellers »collect premium»have obligation if assigned, resulting in a long
position in the underlying futures contract»have time working in their favor
»have performance bond requirements
Option investing and option trading involves risks and may not be suitable for
everyone. Option trading and option investing should only be a part of your
overall options education and options strategy.
About the Author:
For more detailed futures education materials please visit http://www.oxfordfutures.com/education.htm
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