The Advantages of Futures Option Trading

However, one cannot narrow the problem down to a single derivative, or even the derivatives themselves, but rather to human error and leverage. Or, in laymen’s terms, someone got too greedy and didn’t think before they acted. In other words, futures option trading is still a viable way to make a serious return with a low initial capital outlay.

What is a Futures Option?

A futures contract is a contract between two parties where one side agrees to purchase a certain asset, be it stocks, commodities or currencies, at a certain date in the future and at a certain price. A futures contract creates an obligation for the owner of the contract to make the purchase when the contract matures. The investor does not make an upfront payment, depositing instead a margin of 5 – 15% of the total value of the contract with the balance due when the contract matures. However, the goal of most investors is to sell the futures contract before it matures.

An option gives the holder the right to buy or sell the underlying asset but not the obligation to do so. Therefore, if the price is right on the expiration date the owner of the option can exercise his right to make the purchase of the underlying asset. On the other hand, if the price is lower or higher than desired, then the holder can choose not to fulfill the option.

A futures option is an option where the underlying asset is a futures contract. Therefore, a futures option holder has the right to purchase or sell a futures contract at a certain time if the price is right, without investing more than the price of the option.

Why Futures Option Trading?

It is quite normal to wonder why someone would want to complicate matters even further by option for futures option trading when they could purchase the option on the underlying asset directly. The main reason is that a futures contract is often easier to trade than the asset itself. This is especially true of commodities where it is much easier to trade a futures contract on corn than it is to actually take delivery of the corn itself.

Additionally, most futures options are settled in cash as the underlying contract is usually closed out before delivery. This makes it very attractive to investors who do not have access to sufficient funds to purchase the underlying asset when and if they choose to exercise the option.

Futures Option Trading: Pricing

Understanding how an option is priced is critical to futures option trading because it will give you valuable insight into the market. The price of an option doesn’t magically appear nor does someone simply pull a number out of a hat.

The price of an option, also known as a premium, is dependent on a number of variables which are then entered into a calculator that uses a formula such as the Black-Scholes option pricing model to determine the premium. These variables include the current price of the underlying asset, in our case the futures contract, the strike price of the options, number of days until the option matures, volatility and interest rates.

However, don’t expect your result to match the price of the option on the market because there are also other variables at play when it comes to futures option trading on the exchange. The price of the option is also determined greatly by supply and demand. In other words, the more traders that want to invest in a certain futures option, the higher the price will be.

Of course, this merely a quick introduction into futures option trading and you certainly need to further your education if you want to successfully trade derivatives because the more prepared you are the higher your chances of turning a profit. The good news is that it isn’t quite as complex as it may first appear and the returns are definitely worth the low initial investment.

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3. Currency Futures Trading
4. Forex Binary Option
5. The Best Futures Traders See the Forest and the Trees
6. Ins And Outs Of Commodity Futures Trading