Options
What is an option?
An option on a futures contract is the right, but not the obligation, to buy or sell the underlying futures contract at a predetermined price on or before a given date in the future.
Here’s a simple example:
Suppose your company is considering moving to a new city, and you may need to move. You could buy a house in the new city, just in case, but that may not be the best use of your capital. And if the company decides not to move, then you have a house you don’t need.
But, what if you could buy an option on a house in the New City?
You will need to pay the owner of the house for this “right”, and the cost of that right is called the option premium.
If the company moves, you would exercise your option to purchase the house at the predetermined price. If the company does not move, then you would simply not exercise your right or option to buy the house. When this happens, the owner of the house will still keep the option premium.
If the company moves, you would exercise your option to purchase the house at the predetermined price. If the company does not move, then you would simply not exercise your right or option to buy the house. When this happens, the owner of the house will still keep the option premium.
Options on futures work fundamentally the same way, but with more standardized terms, and options permit you to lock in price but with an added layer of flexibility. For example, when you buy an option on a future, you pay an upfront premium, and agree to buy that particular futures contract at a specific price.
You have the right but not the obligation to exercise your option at that price and receive the futures contract. So if prices move against you, you have the option of not exercising the contract.
Every option transaction must have a buyer and a seller.
Buyers pay the premium to the seller, and sellers hold the risk of price movement.
Option Benefits
Options can be used like insurance policies to limit losses on a futures contract.
They can also be used for speculative purposes, whether you are selling options to receive premium income or using options to establish a position in a particular commodity, index or interest rate.
As hedging instruments, options can produce offsetting gains in the face of adverse price changes in the cash market.
Options permit you to efficiently deploy capital, in the form of option premium. In this case, you can participate in the price movements of the underlying asset, without having to buy the asset outright.
Summary
So when it comes to options on futures, both buyers and sellers have an array of choices to efficiently deploy their capital, while expressing their opinion or managing their price risk in the marketplace.
Option Contract Details
Contract details refer to the terms of an option contract. How an option contract gains or loses value, and therefore creates a benefit to you as the holder of the option, is dependent on key option contract details. Understanding the key contract details is essential to determining how and when an option will meet your financial objectives. Choosing the right options contract for you is dependent on your objectives. For example, if you want to protect or hedge an asset, you will need to know the contract details to determine the best fit for your portfolio; when speculating, your trading strategy might be influenced by the contract details.
Key Option Elements
Underlying
The deliverable for every CME Group option is a futures contract. This is called the “underlying instrument” or the “underlier”. Futures contracts also have an underlying product such as an interest rate, equity index, a foreign currency rate, or some other commodity.
Expiration/Maturity Date
Each option also has its own expiration or maturity date. This is the last day on which an option can be exercised into the underlying futures contract. After the expiration or maturity date, the option contract will cease to exist; the buyer cannot exercise and the seller has no obligation.
Strike Price
This is the agreed price at which a transaction will happen, if the option is worth exercising. The strike price for the option contract will determine the value at expiration.
Option Type
Option contracts fall into two categories, call options and put options.
A call option is the right to “buy” the underlying product at a predetermined price.
A put option is the right to “sell” the underlying product at a predetermined price.
Before establishing your option position, you will need to carefully consider your financial strategy and objectives. Whether you are hedging or pursuing a trading strategy, close alignment of the contract details are important to achieving desired results from your option position.