Options on futures, or “futures options,” offer market participants an unparalleled collection of opportunities. However, their name often confuses and discourages many active traders from entering the market. In this blog article, we’ll take a look at the basics of options on futures and three key advantages of making them part of your trading plan.
Futures options are options contracts that use futures contracts as underlying assets. Confused? Don’t be―these products function the same as traditional options contracts. Here is a quick look at the basics of futures on options:
At its core, a futures options contract’s functionality is exactly as its title dictates. It is an options contract that is based on a futures product. Accordingly, you can take long or short positions in a market by buying calls or puts.
As an example, let’s say that you are skittish about the market and think that gold has solid upside potential over the coming six months. It is early June, and CME December gold (GCZ) is trading at $1,750.00; given the emergence of new COVID-19 variants, you think that $2,000.00 by the late fall is a real possibility.
To go long gold using options on futures, all you have to do is buy a call contract at a desirable strike price. If you think that the current market price ($1,750.00) is an intermediate-term floor, then purchasing ITM, ATM, or OTM GCZ calls opens a new long position.
The beauty of this trade is that the only money risked is the cost of the premium. If you’re completely wrong and the price falls to $1,000, you only lose the premium. Conversely, if you were long one futures contract from $1,750.00 and price fell to $1,000.00, the result would be catastrophic (every $1.00 is worth $100, -$75,000).
It is important to remember that all derivatives products have a finite shelf life. For futures and options, this comes in the form of an official expiration date. Upon expiry, a contract is taken off the board and becomes untradable.
Any trades are educational examples only. They do not include commissions and fees.
For options on futures, the option contract typically expires one month before the underlying futures contract. This can be a good or bad thing for an open position because an option’s premium value is subject to time decay (delta). Although this relationship may seem confusing, it actually gives the trader several alternatives. Let’s say that you made your futures options play in June and bought one GCZ call with an $1,800 strike at a premium of $4,000. It is now mid-October, and GCZ has rallied to $1,875 (great call!). Here are your alternatives:
Sometimes the best way to learn about a subject is by talking to a true expert. For more information on how futures options can work for you, schedule a free one-on-one consultation with a StoneX broker today.