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United Futures Trading Company, Inc. Suite Chicago, IL What are known as put and call options are traded on most active futures contracts. The principal attraction of buying options is that they make it possible to speculate on increasing or decreasing futures prices with a known and limited risk. Options can be most easily understood when call options and put options are considered separately, because they are totally separate and distinct. Buying or selling a call in no way involves a put, and buying or selling a put in no way involves a call.
Buying Call Options The buyer of a call option acquires the right, but not the obligation, to purchase go long a particular futures contract at a specified price at any time during the life of the option. One reason for buying call options is to profit from an anticipated increase in the underlying futures price. A call option buyer will realize a net profit if, upon exercise, the underlying futures price is above the option exercise price by more than the premium paid for the option. Or a profit can be realized if, prior to expiration, the option rights can be sold for more than they cost.
You expect lower interest rates to result in higher bond prices interest rates and bond prices move inversely. To profit if you are right, you buy a June T-bond 90 call. As mentioned, the most that an option buyer can lose is the option premium plus transaction costs. In contrast, if you had an outright long position in the underlying futures contract your potential loss would be unlimited. It should be pointed out, however, that while an option buyer has a limited risk the loss of the option premium , his profit potential is reduced by the amount of the premium.
Although an option buyer cannot lose more than the premium paid for the option, he can lose the entire amount of the premium. This will be the case if an option held until expiration is not worthwhile to exercise. Buying Put Options Whereas a call option conveys the right to purchase go long a particular futures contract at a specified price, a put option conveys the right to sell go short a particular futures contract at a specified price.
Put options can be purchased to profit from an anticipated price decrease. As in the case of call options, the most that a put option buyer can lose, if he is wrong about the direction or timing of the price change, is the option premium plus transaction costs.
However, you could have lost the entire premium. How Option Premiums are Determined Option premiums are determined the same way futures prices are determined, through active competition between buyers and sellers.
Three major variables influence the premium for a given option:. Said another way, an option is an eroding asset; its time value declines as it approaches expiration. All else being equal, the greater the volatility the higher the option premium. In a volatile market, the option stands a greater chance of becoming profitable. Selling Options At this point, you might well ask, who sells the options that option buyers purchase?
The answer is that options are sold by other market participants known as option writers, or grantors. Their sole reason for writing options is to earn the premium paid by the option buyer. If the option expires without being exercised which is what the option writer hopes will happen , the writer retains the full amount of the premium.
It should be emphasized and clearly recognized, however, that unlike an option buyer who has a limited risk the loss of the option premium , the writer of an option has unlimited risk. Simply said, any profit realized by an option buyer represents a loss for the option seller. The foregoing is, at most, a brief and incomplete discussion of a complex topic. Options trading has its own vocabulary and its own arithmetic. If you wish to consider trading in options on futures contracts, you should discuss the possibility with your broker and read and thoroughly understand the risk disclosure statement which he is required to provide.
In addition, have your broker provide you with educational and other literature prepared by the exchanges on which options are traded. Or contact the exchange directly. A number of excellent publications are available, including Options on Futures Contracts: Past performance is not necessarily indicative of future results. The risk of loss exists in futures and options trading. Past performance is not necessarily indicative of future results and the risk of loss does exist in futures trading.
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Options on Futures Contracts. This publication is the property of the National Futures Association. Return to table of contents What are known as put and call options are traded on most active futures contracts. A March Treasury bond 92 call option would convey the right to buy one March U.