Why Futures Options Trading?

There are two basic types of futures options – stock options futures and commodity options. But to enjoy a play on words for a moment, you could say options are options are options. In other words, the underlying financial instruments may be different depending on the options on futures contract you choose or the stock option you choose, but the definition of an option is the same.

What is an option? It is a contract that conveys a right, but not an obligation, to an option buyer. The right is the right to buy or sell an underlying asset at a specific price and at a specific point in time. That time is in the future which is why it’s called a futures option. An option is a financial vehicle used for investment purposes similar to buying stocks or mutual funds.

There are a number of reasons why people consider futures option trading.

Leverage

When you buy a stock or a bond, it is necessary to actually buy the stock or the bond. When buying a futures option, you don’t pay for the underlying asset. You pay for the right to buy the underlying asset. What you pay is called the premium and there will also be commission and transaction fees. Instead of buying $5,000 worth of stock, you pay a fraction of that to buy the right to purchase the asset later. The stock may be worth $7,000 by the expiration date but you are able to still buy it at $5,000. Until the option expires you control 100 shares of stock per option.

The power and versatility of leverage cannot be underestimated.

Hedging

Futures options are purchased for the purpose of hedging too. Hedging lets you reduce your risk by limiting the downside. You can set up a trade that involves both buying and selling futures options in a way that maximizes your profit while limiting your losses. Hedging involves using one contract to offset another. Of course, you would institute complex hedging strategies until you are comfortable with trading options.

Protect Your Investments

Because you can control an underlying asset for a specific period of time with futures options, you give yourself some protection from unanticipated market price moves. The same holds true on the price side also. Because the options contract lets you buy a stock or a futures contract at a particular price, you know that until the option expires you are assured of being able to buy the asset under a call option when it’s in the money. If the option is out of the money, you can simply let your option expire.

It works the same way for put options too. You reserve the right to sell assets at a set price in the future.

Learning how to manage risks is critical when futures options trading. There are many tools available though that make the job of figuring break-evens and risk much easier. There are pricing models for example that are computerized. You just plug the variables in and the software will calculate the best price and provide a number of other variables.

In addition, there is a wealth of information available through the big options trading exchanges. By completing tutorials and learning how the various strategies work you can learn to utilize futures options trading to your benefit.

Related posts:

• Going for Profits with Futures Option Trading
• Futures and Options… the Optional Investment Future