Understanding the basics of futures options trading
Futures options trading is a skill that takes a bit of knowledge and experience to have any chance of success. The knowledge required is often hard to find and can seem esoteric to the new investorm but the concept of futures options is not too difficult to grasp, so long as its explained in basic English and you already have a basic understanding of the workings of futures contracts. FuturesInvest.info is a valuable link which should help explain the underlying futures contracts if you need to visit it please book mark this page so you can come back when you have your questions answered.
An option is the right, but not the obligation, to buy (or sell) a specific futures contract on or before a specific date in the future.
This definition is very close to that of a futures contract except the owner is not obligated to cover the price move of the underlying contract. Instead, the owner of an option can choose to convert it to a futures contract if and only if it is in his interest to do so.
Before we get too far into the details of commodity options you should understand that there are two types of options, puts and calls. A put option is the right to sell something at a set price and a call option is the right to buy something. If you suspect that the price of something will go up you would buy a call option and if you thought it would go down you'd want a put. It is also important to understand that you have the ability to buy or sell options. Just like with futures contracts, for every option buyer there must be a seller to take on the opposite side of the transaction.
If the current price of the S&P 500 is 1,400 and you thought it would go up then you could either buy a call or sell a put to profit from the move. If the date is January 1st and you buy a March option with a strike price of 1,450 then you have until March to see the S&P trade above 1450. If it does then your option to buy will be in the money and therefore profitable. If the market went to 1,500 and you paid 20 for the call then your profit at expiration would be 50 points minus the 20 you paid. By purchasing a call you can make an infinite amount while only risking the amount you paid. If the market goes straight down then so too will your options value.
The seller (or writer) of a call option wants the market to stay below the strike price. While he does collect a premium in the form of the initial amount the buyer paid for the call, he's exposing himself to a large move through the strike price of the option he wrote. The owner of an option that goes in the money makes money and the person who wrote it will lose. The benefit to the writer comes from the fact that so many options expire worthless. Often times for an option to be profitable, there needs to be a very large price movement in the underlying asset. Even in the example above, the owner of the S&P calls needed an 8% move in a few short months to make a 150% profit on the option trade.
To further understand futures option trading you need to know the basic fundamentals of options which break down into the following areas:
Futures-Option-Trading.com
1: Futures option trading basics
2: How to price futures options
3: Understanding the Greeks
4: Using option spreads
5: Synthetic options and futures
6: Strategies
7: Tips for buying and selling
8: Risk Disclosures for options
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