The Basics of Trading Options on Futures
An option on a futures contract gives the buyer the right, but not the obligation, to buy (call) or sell (put) a specific futures contract at a set strike price before the option expires. The buyer pays a premium to the seller, and exercise delivers a futures position rather than shares. Because futures are already leveraged, options on them add leverage on top of leverage, so traders need to understand the futures contract, margin, and expiration dates before trading them.
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What is a Futures Contract?
A futures contract is an agreement to buy or sell a (usually standardized) commodity at a stated time in the future for a pre-agreed price. Such agreements involve two parties – a buyer and a seller. The parties must have an agreement arrangement with a broker and the contract must be registered and approved by an exchange. Standardized futures contracts trade on exchanges such as CME Group's Chicago Mercantile Exchange and ICE Futures Europe. E-mini contracts (for example the E-mini S&P 500) are smaller-sized futures listed on the CME.
What are Options on Futures?
Options on futures are financial instruments that grant the right, but not the obligation, to buy or sell a contract underlying asset at a pre-determined price. They are the building blocks of many sophisticated financial strategies and offer a wide range of potential. Options can be used to manage risk exposure, generate income and manage time decay.
How Options Work
Options are relatively simple to understand but can have a wide range of application. To buy an option, a trader pays the seller a premium, plus any exchange and broker fees. The seller keeps the premium and takes on the obligation to deliver or take the futures position if the option is exercised.
Types of Options
Options come in two forms – calls and puts. Calls give the investor who buys them the right, but not the obligation, to buy the underlying asset at a specific price. Puts give the same right to sell. An investor can use one of two different strategies to trade options: buying or selling.
Benefits of Trading Options
Options provide leverage, allowing traders to control a large position using a relatively small amount of capital. Options also offer a degree of protection against downside risk, while still offering the potential for profit. Options also can be used to ensure a consistent income stream, increase their exposure to the market and manage their risk exposure.
Risks Associated with Trading Options
The leverage and protection of options can come at a cost – risk. A long call has unlimited upside, but option buyers can lose the whole premium, and option sellers can face losses far larger than the premium they collected. Options are an inherently risky asset class, and many traders are not able to make a profit from them. Before trading options, it is important to understand the risks associated.
Options on Futures Strategies
Options can be used for a wide range of strategies, such as hedging, generating income. Spreads, creating leverage and managing time decay. Some of the most common strategies include buying and selling options, writing covered calls and buying and selling volatility.
Margin Requirements and Expiry Date
When trading options on futures, margin requirements and expiry dates must be considered. Margin requirements are the amount of money required to cover potential losses and is typically a percentage of the position size. The buying and selling of options can also be affected by the expiration date of the options, which is the day on which the option expires and is no longer valid.
Using MarketXLS to Trade Options on Futures
MarketXLS is an Excel add-in for market data and analysis. You can use its functions to pull prices, price history, and technical indicators into a spreadsheet and build models for the positions you trade through your broker. Check the MarketXLS formulas page for the futures and options symbols and functions available on your plan.
The success of any of these strategies depends on the trader's knowledge and risk management. This article is educational, not investment advice.
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