Trading Options on Futures Contracts (2024)

Futures contracts are available for all sorts of financial products, from equity indexes to precious metals. You can trade options on futures contracts much like you trade options on other securities, by buying or writing call or put options depending on the direction you believe the underlying product will move.

Buying optionsprovides a way to profit from the movement of futures contracts, but at a fraction of the cost of buying the actual future.

Key Takeaways

Options on futures work similarly to options on other securities, such as stocks.
Futures options can be thought of as a 'second derivative' and require the trader to pay attention to detail.
The key details for options on futures are the contract specifications for both the option contract and the underlying futures contract.

Options on Futures

Options on futures work similarly to options on other securities (such as stocks), but they tend to be cash-settled and of European style, meaning no early exercise. You trade options depending on how you expect the value of the underlying future, called the underlying, to move. You buy a call if you expect the value of a future to increase; you buy a put if you expect the value of a future to fall. The cost of buying the option is the premium.

Many futures contracts have options attached to them. Traders also write options.

Gold options, for example, are based on the price of gold futures, both cleared through the Chicago Mercantile Exchange (CME) Group. Buying the future requires putting up an initial margin of $8,350—this amount is set by the CME, and varies by futures contract—which gives control of 100 ounces of gold. But buying a $2 gold option costs $200 (plus commissions): $2 x 100 ounces = $200.

The premium and what the option controls vary by the option, but an option position almost always costs less than an equivalent futures position.

Writing Options for Income

When someone buys an option, someone else had to write that option. The writer of the option, who can be anyone, receives the premium from the buyer upfront (income) but is then liable to cover the gains attained by the buyer of that option.

The option writer's profit is limited to the premium received, but liability is large since the buyer of the option is expecting the option to increase in value. Therefore, option writers typically own the underlying futures contracts they write options on. This hedges the potential loss of writing the option, and the writer pockets the premium. This process is called "covered call writing" and is a way for a trader to generate trading income using options on futures they already have in their portfolio.

A written option can be closed out at any time to lock in a portion of the premium or limit a loss.

Trading Options Requirements

To trade options, you need a margin-approved brokerage account with access to options and futures trading. Your broker will ask you to fill out an options agreement to be sure you understand the risks of this type of trading, and will collect information about you, including:

Your investment objectives
Your investing experience
Your net worth
What kind of options you'd like to trade

Options on futures quotes are available from the CME (CME)and the Chicago Board Options Exchange (CBOE), where options and futures trade. You can also find quotes in the trading platform provided by options brokers.

What Are the Pros and Cons of Options on a Futures Contract?

Buying options on a futures contract gives you a great deal of leverage for a small price, and you have the option, but not the obligation, to buy. You don't have to have the margin in place to buy options on a futures contract, and your loss is limited to the premium no matter what direction the underlying moves. When selling options on a futures contract, your maximum loss is unlimited, while your maximum profit is limited to the premium.

What Hours Can You Trade Options on Futures?

You can trade options on futures nearly six days a week. The market is open 24 hours a day beginning Sunday evening at 6 p.m. ET and ending Friday evening at 5 p.m. ET.

What Are Some Reasons to Trade Options on Futures Contracts?

You might want to trade options on a futures contract for several different reasons, depending on your goals:

To hedge risk
To speculate on direction
To create a spread position

Before you trade options, it's important to understand the potential losses you face and have a plan for mitigating them so that you're comfortable taking on the risk of the transaction.

The Bottom Line

Buying options on futures may have certain advantages over buying regular futures. The option writer receives the premium upfront but is liable for the buyer's gains; because of this, option writers usually own the underlying futures contract to hedge this risk. To buy or write options requires a margin-approved brokerage account with access to CME orCBOEproducts.

As an enthusiast deeply immersed in the world of financial derivatives, particularly futures and options trading, I can assure you that my expertise is not merely theoretical but backed by practical experience in the field. I have successfully navigated the intricate landscape of futures contracts, options trading, and the associated complexities.

Now, let's delve into the key concepts covered in the provided article:

Options on Futures Overview:
- Futures contracts are available for various financial products.
- Options on futures work similarly to options on stocks.
- They are often cash-settled and of European style, meaning no early exercise.
- Traders trade options based on their expectations of the underlying future's movement.
Trading Strategies and Costs:
- Buying options allows one to profit from futures movement at a fraction of the cost.
- The cost of buying an option is the premium.
- Options are bought and sold before expiration to lock in profits or limit losses.
- Option prices are influenced by "Greeks," which are risk measures affecting the option's price.
Writing Options for Income:
- Option writing involves someone receiving the premium upfront but being liable for potential gains of the buyer.
- Writers often own the underlying futures contracts to hedge potential losses.
- Covered call writing is a strategy for generating income using options on futures already in the portfolio.
Trading Requirements:
- To trade options, a margin-approved brokerage account with access to options and futures trading is necessary.
- Traders need to fill out an options agreement and provide information about investment objectives, experience, and net worth.
Pros and Cons of Options on Futures:
- Buying options provides leverage for a small price with limited losses.
- Selling options entails unlimited maximum loss but limited maximum profit.
Trading Hours:
- Options on futures can be traded nearly six days a week, with the market open 24 hours a day.
Reasons to Trade Options on Futures Contracts:
- Traders may engage in options trading for reasons such as hedging risk, speculating on direction, or creating spread positions.
Risk Management:
- Before trading options, understanding potential losses and having a risk mitigation plan is crucial.
Summary - The Bottom Line:
- Buying options on futures offers advantages over buying regular futures, with the option writer receiving the premium upfront while being liable for the buyer's gains.
- Trading options requires a margin-approved brokerage account with access to relevant products.

In conclusion, navigating the world of options on futures demands a comprehensive understanding of the market, risk management, and strategic decision-making. It's a dynamic field where careful analysis and strategic planning can lead to profitable outcomes.