Before you can trade futures options, you need to learn the basics.
What are Futures Options?An option is the right, not the obligation, to buy or sell a futures contract at a designated strike price. For trading purposes, you buy options to bet on the price of a futures contract to go higher or lower. There are two main types of options - calls and puts.
Calls – You would buy a call option if you believe the underlying futures price will move higher. For example, if you expect corn futures to move higher, you will want to buy a corn call option.
Puts – You would buy a put option if you believe the underlying futures price will move lower. For example, if you expect soybean futures to move lower, you will want to buy a soybean put option.
Premium – You are obviously going to have to pay some kind of price when you buy an option. The term used for the price of an option is premium. You can think of the pricing of options as a bet. The bigger the long shot, the less expensive they will be. Oppositely, the more sure the bet is, the more expensive it will be.
Contract Months (Time) – Options have an expiration date, which means they only last for a certain period of time. When you buy an option, you cannot hold it forever. For example, a December corn call expires in late November. You will need to close the position before expiration. Generally, the more time you have on an option, the more expensive it will be.
Strike Price – This is the price at which you could buy or sell the underlying futures contract. For example, a December $3.50 corn call allows you to buy a December futures contract at $3.50 anytime before the option expires. Most traders do not convert options, they just close the option position and take the profits.
Example of Buying an Option:Let’s say you expect the price of gold futures to move higher over the next 3-6 months. It is currently January, so you would probably buy an August gold call to give yourself enough time. Gold is currently trading at $590 per ounce. You expect the price to climb to $640 within 6 months.
You purchase: 1 August $600 gold call at $15
- 1 = number of options you are buying
- August = Month of option contract
- $600 = strike price
- Gold = underlying futures contract
- Call = type of option (bet on price moving higher)
- $15 = premium ($1,500 is the price to buy - 100 ounces of gold x $15 = $1,500)