What is an Options Contract?
There are two types of options: calls and puts. A call gives the
holder of the options contract the right, but not the obligation,
to buy the underlying futures contract. Conversely, a put gives the
holder the right but not the obligation to sell the underlying
futures contract.
The price at which the underlying futures contract may
be bought or sold is the exercise price, also called the
strike price. An options contract affords the right to
buy or sell for only a limited period of time; each options
contract has an expiration date.
On the opposite side, a seller, or writer of an options
contract incurs an obligation to perform, should an options
contract be exercised by the purchaser. The writer of a
call incurs an obligation to sell a futures contract and
the writer of a put has an obligation to buy a futures
contract.
Options Rights and Obligations
CALL
-
Buyer has the right to buy a futures
contract at a predetermined price on or before a defined
date
-
Seller grants right to buyer, and therefore has an obligation
to sell futures at a predetermined price at buyer's sole option
Buyer's Expectation: Rising Prices
Seller's Expectation: Neutral or Falling
Prices
PUT
-
Buyer has the right to sell a futures contract
at a predetermined price on or before a defined date
-
Seller grants right to buyer, so has obligation to
buy futures at a predetermined price at buyer's sole
option
Buyer's Expectation: Falling Prices
Seller's Expectation: Neutral or rising
prices
In return for the rights they are granted, options
buyers pay options sellers a premium. There are four
major factors
affecting the price of an options contract:
-
The price of a futures contract relative to the options
strike price
-
Time remaining before options
expiration
-
Volatility of underlying futures price
-
Interest rates
An options contract is a wasting asset.
It has an initial value that declines, or wastes
away, as time
passes. Depending
upon the movement of an options price, the buyer
will choose one of three alternatives for terminating
an options position:
While liquidation
is the most common choice, a small percentage
of buyers choose to exercise
their options,
particularly
if their strategy calls for acquiring a long
or short futures position at the strike price.
The ability
to trade in and
out of positions is the great advantage of
standardized options contracts.
If the futures price does
not move far enough for an exercise to be worthwhile,
or moves
in the opposite
direction, buyers
can simply let their options contract expire
valueless.
Because trading on the Exchange
is conducted among anonymous counterparties, when an
options contract is exercised,
the Exchange randomly assigns an options writer to fulfill
the obligation.
As in the futures market, options trading
takes place in a primarily open outcry auction market
on the Exchange.
While the value of futures is tied to the underlying
cash commodity through the delivery process, the value
of an
options contract is related to the underlying futures
contract through the ability to exercise the option.
More
Information on Commodity Trading
Commodity
Options on Futures
Edge Financial Group is registered and licensed as
an Introducing Broker with the Commodity Futures Trading Commission,
the federal regulatory agency of futures and options. We are also
a member of the National Futures Association, a self-regulatory agency
working with the Commodities Futures Trading Commission. Our firm is fully licensed.
Please call to speak with an account executive:
1.866.986.EDGE
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