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All you must know about trading futures options

What are future options?

Futures options are contracts that give the holder the right, but not the obligation, to buy/sell a futures contract at a specified price on or before a given date. Futures options are standardized by the Chicago Mercantile Exchange (CME), which means that each option has a fixed expiration date, underlying asset, and strike price.

How do future options work?

When you buy a futures option, you’re paying for the right to either buy or sell a futures contract at a set price on or before a specific date. If you think prices will go up, you might buy a call option, which gives you the right to buy the underlying asset at the strike price on or before the expiration date. If you think prices will go down, you might buy a put option, which gives you the right to sell the underlying asset at the strike price on or before the expiration date.

If you don’t exercise your option, it expires worthless, and you lose the entire premium you paid for it.

Some of the critical considerations when trading futures options

Futures options are a type of derivative instrument, meaning their value is derived from the price of an underlying asset. As such, there are a few key considerations you need to take into account when trading futures options:

The time value of the option

The closer to expiration a futures option gets, the more its time value decreases. As expiration approaches, the chances of the option being exercised decrease.

The volatility of the underlying asset

The more volatile the underlying asset, the more expensive options on that asset will be. It’s because volatility represents a risk, and investors are willing to pay more for protection against risk.

The price of the underlying asset

The underlying asset’s price will affect both the time value and the intrinsic value of a futures option. For example, if you buy a call option with a strike price of $50 and the underlying asset is trading at $60, the option has an intrinsic value of $10. However, if the underlying asset is trading at $40, the option has no intrinsic value but still has a time value.

How to trade futures options

If you want to trade futures options, you’ll need to open a futures trading account with a broker that offers futures trading. Once you have an account set up, you can start placing orders.

Buying options

To buy a call option, you would place a ‘buy’ order for the number of contracts you want to purchase. For example, if you wanted to buy ten contracts, you would enter ’10’ into the quantity box.

To buy a put option, you would place a ‘buy’ order for the number of contracts you want to purchase. For example, if you wanted to buy ten contracts, you would enter ’10’ into the quantity box.

Remember, when buying an option, you’re paying for the right to either buy or sell a futures contract at a set price on or before a specific date. So, if you want to buy an option and plan on never using it, you’ll need to make sure you sell it before it expires.

Selling an option

When selling an option, remember that you’re selling the right to someone else – so they have the chance to exercise it.

If you’re selling a call option, you’re giving the buyer the right to buy the underlying asset at the strike price on or before the expiration date. If you’re selling a put option, you’re giving the buyer the right to sell the underlying asset at the strike price on or before the expiration date.

You can either sell an option for its intrinsic value or its time value when selling it. Keep in mind that if you sell an option for its time value, you could miss out on potential profits if the underlying asset moves in your favour.

The bottom line

Before trading futures options, it’s essential to understand the critical considerations involved. So, make sure you do your research and always use a stop-loss order when trading volatile markets

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