Futures option or futures option
Futures option or futures option - An option is a type of option whose underlying asset or underlying instrument is a specified asset or underlying instrument. futures contract. Thus, it is an option whose holder has the right (but not the obligation) to buy or sell a specified futures contract at a specified time and to receive the rights and obligations arising therefrom.
Basic principles of the futures option
Many futures exchanges offer such options on most of the futures contracts traded on them. In the US, they are popular options on futures contracts on Treasury bonds, grains, soybeans, beans, crude oil, live cattle, gold, and some currencies.
Futures option has all the features of a regular option contract except that the asset is a futures contract. The writer of this option undertakes to sell or buy the futures contract. In this case, the futures contract's strike date must occur shortly after the delivery date of the option contract (e.g., two weeks later). The buyer pays a premium to the seller and the exchange's clearing house acts as guarantor. Options on futures contracts are European options, i.e. they are exercisable only on the expiration date specified in the contract.
As a result, if the holder of such a call option is able and willing to exercise his option, he receives the difference between the exercise price of the option and the current price of the futures contract. Typically, the premiums for an option on a futures contract and simply an option on the asset underlying the futures contract are the same (if the futures and the option have the same expiration date).
Futures put and call options
On Western exchanges, there are put and call options on futures contracts. Any investor can be both a buyer and a seller (overwriter) of put and call options on futures contracts.
An example of how a futures call option works
If a call (buy) option on a futures contract is submitted for execution, the option writer must deliver the corresponding number of futures contracts to the buyer (holder), i.e. after that the seller automatically takes a short position on the futures and the buyer gets a long position on these futures.
For example, one buys option call on May corn futures with the strike price of $3 per bushel. The volume of the contract is 5000 bushels. The total strike price is 5000*3 = 15,000 dollars.
The buyer pays a premium in an amount set by the seller (assume 9.5 cents or $0.095 per bushel, which would be $475).
If the buyer subsequently decides to exercise the option, the superscriber will futures option must deliver to the buyer a May corn futures contract with a delivery price ($3) specified in the option. Clearly, the buyer is not obliged to exercise this option and this reduces his risk in case of unfavorable price movements.
If the futures contracts are already selling for $4 per bushel at the time the options are exercised, clearing - cash settlement - can take place. The seller pays the difference at $1 per bushel or $5,000.
Seller's loss = $5,000 - $475 (premium) = $4,525. Buyer's gain = $5,000 - 475 = $4,525 (excluding commissions).
Example of how a futures put option works
If put option on futures is submitted for execution, the writer shall take delivery of the relevant futures contracts from the holder of that futures option, i.e. the seller shall take a long position in the futures contract (buy the futures in exchange for a short position in the option). And the option holder takes a short position on the futures contract (sells the futures in exchange for a long position on the option). Thus, when a futures put option is exercised, its writer becomes the futures holder and the option holder becomes the futures writer and they both assume the obligations of the futures contract.
For example, a futures put option on May corn is purchased with a strike price of $3 per bushel or a total of $15,000. This pays a premium to the option writer of 15.75 cents per bushel, or a total of $787.5.
If the option holder subsequently decides to exercise the option, the writer must take delivery of a May futures contract with the same strike price from the option holder. If the option is not exercised, the option holder's loss will be the amount paid to the overwriter in premium ($787.5). At the moment of the futures expiration, clearing between the participants of these positions shall be performed.
Most futures options is not exercised, most often reverse trades are made prior to the exercise date. Both parties can execute a reverse transaction at any time prior to the exercise date. Even after an option has been exercised and a corresponding futures position has been opened, it is possible to execute an offset transaction in the futures market.
Thus, options, futures and futures options can exist simultaneously on the same underlying asset.