What is a Future Option?

May 15, 2020

A futures option is a type of security that grants the trader the right to buy or sell a futures contract at a specific price by a specific date. There are two types of futures options: call options and put options. Call options give the owner the right to buy a futures contract, Put options give the owner the right to sell a futures contract. Traders will buy call options when they think the market will rise, and they will buy put options when they think the market will fall.

Futures options are offered to trade on most futures contracts and are traded on various exchanges throughout the United States and internationally. The largest of these exchanges is the Chicago Mercantile Exchange. Futures options are generally traded in a separate futures account with a futures broker dealer.

Each futures options contract has unique contract specifications which make them more complex to trade than stock options or individual futures contracts. Specifically, futures options often have a different expiration date prior to the expiration date of the underlying future. Futures options usually expire near the end of the month that precedes the delivery month of the underlying futures contract (i.e. March option expires in February).

Each futures option contract also has the same contract value as the underlying future, which represents the amount of the commodity to be traded. For example, a crude oil futures contract represents 1000 barrels of crude oil which has a value of approximately $60,000 (1000 X $60 per barrel).

In order to trade any futures contract, traders are required to put up a good faith deposit called margin, which sets aside money in your account in the event of losses. For example, to trade one Crude Oil contract would require $5,000 of margin in order to control 1000 barrels of crude oil. Day traders who do not hold their position overnight get a reduced margin rate of 12.5 to 25 percent of the overnight rate.

Futures options are traded in contracts, and each futures option contract represents 1 contract of the underlying commodity. There can be multiple weekly and monthly futures option contract series that all relate or deliver into the same unique underlying futures contract.

The price or premium of a futures option contract is determined by a number of pricing factors that include:

The underlying futures price
The contract strike price at which you can buy or sell the future at expiration
The expiration date of the contract
Volatility as a function of risk to the trader selling the call or put

The price quoted for a futures option is the per-contract price of the option. So, if an option is quoted at $2 and the point value of the underlying futures contract is 1000, the cost to buy that futures option would be $2,000 ($2 X 1000 shares).

Learning which futures option to buy or sell and when to buy or sell, when to hold your position and when to close your position requires knowledge and experience you can gain through education and coaching.

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