What are Futures Options?
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