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 »pay premium »have right to exercise, resulting in a long futures position »have time working against them »have no performance bond requirements.

Call Sellers »collect premium »have obligation if assigned, resulting in a short position in the underlying futures contract »have time working in their favor »have performance bond requirements

Put Buyers »pay premium»have right to exercise, resulting in a short futures position»have time working against them»have no performance bond requirements

Put Sellers »collect premium»have obligation if assigned, resulting in a long position in the underlying futures contract»have time working in their favor »have performance bond requirements

Option investing and option trading involves risks and may not be suitable for everyone. Option trading and option investing should only be a part of your overall options education and options strategy.