OPTIONS 101 - LEARN ABOUT FUTURES OPTIONS TRADING & COMMODITY OPTIONS TRADING

What is an option?

It is a contract for the right to buy or sell a futures contract for a specified price (strike price) on or before a specific date (expiration date). Options on futures are traded in serial months, meaning the January, February and March options are all based on the underlying March futures, April, May and June options are based on the underlying June futures, and so on. Options come in two forms: calls and puts: A call
option gives the holder the right, but not the obligation, to buy an underlying future at a fixed price during a fixed period of time. A put option gives the holder the right, but not the obligation, to sell an underlying future for a fixed price during a fixed period of time.

There are four fixed components to an option:

The underlying future, the type of option (put or call), the strike price, and the expiration date. For each option traded, there is the buyer and the seller, also refered to as the writer. The following is a recap of options terminology:

:::::>Call

an option which gives the buyer the right to be long a futures contract at a specific price (strike price) and the seller the responsiblity of being short at the same price

:::::>Put

an option which gives the buyer the right to be short a futures contract at a specific price (strike price) and the seller the responsibility of being long at the same price

:::::>Strike Price

the specified price of the option usually in increments. For example, if the SWISS FRANC is trading .7947, strike prices would include 77,78,79,80, and so on.

:::::>Expiration

the date when an option expires. In the US, options are 'American style,' meaning they can be exercised at any time between the date of purchase and the expiration date, which would be the month of the underlying futures contract's expiration.

:::::>Premium

the price one pays or receives for an option. It is determined by several factors: futures price, strike price, time to expiration, implied volatility and interest rates. (See our explainantion of options pricing.)

:::::>Buyer

The person who purchases either a call or put option is the option 'buyer.' He pays the premium, or current price, of the option and has the right to exercise the option if he so wishes. No margin is required to hold these options. The only money risked in holding this type of position is the initial price paid for the option.

:::::>Seller

The person who sells the put or call is the option 'seller.' He collects the premium, or current price, of the option but has the obligation to take a position if his option is exercised. He must also put up the margin required to hold the option in his account. This position has unlimited risk because the seller is obligated to make good on the contract if it is exercised. For instance, if he sold 1 call and it is exercised, he now is short 1 future. If he sold 1 put and it is exercised, he is now long 1 future.

How do basic options orders work?

:::::>Call Option Orders

The buyer of a call option has purchased the right to buy 1 contract of the underlying future at the stated exercise price. Thus, the buyer of one June Yen 115 call option has the right to purchase 1 June Yen future at $115 from now until June expiration. The seller of a call option has sold the right to buy 1 contract of the underlying future at the stated price.

:::::>Put Option Orders

The buyer of a put option has purchased the right to sell 1 contract of the underlying future at the stated exercise price. Thus, the buyer of one June Yen 115 put has the right to sell 1 June Yen future at $115 from now until the June the expiration date.

Why trade options?

Options are just another way to take a position in the market. Although their value is based on an underlying future, they offer more flexibility than the futures contract but can be more or less risky. Since an option only has value for a fixed period of time, its value decreases, or 'wastes' away, with the passage of time and is considered as a 'wasting' asset. Nevertheless, options allow a holder to participate in market moves with greater leverage than outright positions, while also limiting his risk to a predetermined amount.

Try this option pricing calculator - Black ­ Scholes.

Robert's Online Option Strategy: Online applet allows you to visualize various options strategies such as puts, calls, spreads, straddles and butterflies in 3D graphical format.