Options on Futures Separate market Option on the futures contract

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Presentation transcript:

Options on Futures Separate market Option on the futures contract Can be bought or sold Behave like price insurance Is different from the new insurance products

Options on Futures Two types of options Four possible positions Put Buyer Seller Call

Strike price Level of price insurance Set by the exchange (CME, CBOT) A range of strike prices available for each contract

Premium Is traded in the option market Different premium CMEgroup.com Buyers and sellers establish the premium through open out cry in the trading pit. Different premium For puts and calls For each contract month For each strike price CMEgroup.com

Premium Depends on five variables Strike price Price of underlying futures contract Volatility of underlying futures Time to maturity Interest rate

In-the-money If expired today it has value Put: futures price below strike price Call: futures price above strike price

At-the-money If expired today it would breakeven Strike price nearest the futures price

Out-of-the-money If expired today it does not have value Put: futures price above strike price Call: futures price below strike price

Option buyer alternatives Let option expire Typically when it has no value Exercise right Take position in futures market Buy or sell at strike price Re-sell option rights to another

Buyer decision depends upon Remaining value and costs of alternative Time mis-match Most options contracts expire 2-3 weeks prior to futures expiration Cash settlement expire with futures Improve basis predictability

Option seller Obligated to honor option contract Can buy back option to offset position Now out of market

Net Price with Options Buy Put Buy Call Minimum price Cash price - premium - comm Buy Call Maximum price Cash price + premium + comm

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