Futures Options : A Beginners Guide to Options on Futures (2024)

Futures Options: A Beginners Guide to Options on Futures (1)

by Gavin in Blog

July 31, 20210 comments

Futures Options: A Beginners Guide to Options on Futures (2)

Chances are you may know about options. Perhaps you have also heard of futures. But have you heard of Futures Options?

Futures Options can sometimes provide the best of both worlds for traders on certain products.

This article will break down what Futures Options are. We will then explore some of the benefits and times to use them in a portfolio.

Contents

  • What are Futures Options?
  • What are the Benefits of Future Options?
  • Does this make Futures Options more Profitable than Options?
  • How are Futures Options Settled?
  • Should I Trade the Futures or Futures Options?
  • Concluding Remarks

What are Futures Options?

A futures option is an option on a futures contract that gives the holder the right to buy or sell a given asset at a specific price for a certain period of time.

If this sounds similar to an options contract it is because they are almost the same.

A futures call option for example will have the same exposures to greeks that a call option on a stock would have.

Being long delta, gamma and vega while being short theta.

Thus, if you have experience with options, branching into futures options isn’t difficult.

The major difference is that the underlying in this case is not a stock or an ETF, it is a futures contract itself.

What are the Benefits of Future Options?

1. They are More Margin Efficient

The biggest benefit to trading futures options is access to greater leverage though SPAN Margin.

This allows options sellers to trade substantially more size than available from selling options on stocks, as this uses Reg T margin.

Below is an example of the margin requirement for selling one at the money Futures Options Put on an ES contact.

Futures Options: A Beginners Guide to Options on Futures (3)

We can see that by selling this ES put we receive a credit of $1,275 (in yellow) and have to provide $11,112 in Initial Margin (in red).

Now let’s compare that to selling 5 SPY puts which is the same notional value as our one ES futures option.

Futures Options: A Beginners Guide to Options on Futures (4)

Here we have the same credit and have the same exposures.

We are selling the same notional value on the S&P 500.

Despite this we have a shocking $62,516 margin we have to provide!

This is all because of the SPAN vs REG-T calculation, not due to real risk.

In this case, the superior margin efficiency under SPAN margin makes selling the ES option a much better bet.

2. Futures Options are Superior for Commodity and Currency Volatility.

For trading volatility on currencies and commodities outside of gold, silver and oil it is almost necessary to trade the futures options.

This is because the ETFs tracking these products are few and illiquid.

For example, if a trader wanted to trade soybeans the largest ETF, SOYB has only a hundred million dollars of assets under management and relatively illiquid options.

This makes it difficult to trade.

In contrast Soybean futures and futures options are liquid, margin efficient and allow investors to get the exact exposures they want.

Does this make Futures Options more Profitable than Options?

The simple answer is no.

It only allows traders to apply more leverage.

When you have two trades with a positive expected value applying more leverage will increase profitability.

If you have no advantage in your trade adding leverage doesn’t add profitability.

If anything, you will just end up losing money faster.

How are Futures Options Settled?

One of the most confusing things about futures options is settlement.

Regular options on stocks and ETFs will involve settlement by purchasing or receiving the specified number of shares if the contract ends in-the-money.

For equity futures options settlement is normally to the underlying futures contract or simply to cash. As shown from the ES settlement details below.

Futures Options: A Beginners Guide to Options on Futures (5)

Source: Tastytrade

We can see here the options for all the major quarterly expirations settle to cash while other expires settle to the upcoming futures contract.

In the event that the futures option is settled to cash there is no further action needed.

If it is settled to the underlying future, one simply buys or sells the future position on assignment or closes the options position before assignment to the future.

In contrast most commodity and currency futures require physical delivery.

If you are reading this article chances are you do not have the capacity nor permissions to store 1,000 barrels of oil in your backyard!

Hence you will be forced to close out a position before settlement and delivery.

If you wish to maintain exposure one can simply establish a new options position in the next futures cycle.

If you forget to close out the position after a few reminders from the brokerage your position will be liquidated.

This usually isn’t the end of the world as liquidity is generally good.

Should I Trade the Futures or Futures Options?

In order to decide whether to trade futures or futures options it is important to establish your view on the asset you want to trade.

As a speculator if you do not have a view on the volatility of the instrument you are trading it is almost always better to trade the underlying.

This holds true for stocks vs. options.

The same applies for futures and futures options.

The reality is the futures contract will always be more liquid than the futures options.

Futures Options: A Beginners Guide to Options on Futures (6)

When a trader purchases or sells future options they introduce all the greeks into the equation.

An example.

Imagine John is bullish on the price of oil.

The May Crude oil contract is trading at $60 so he buys the $80 call for $1.50.

John is right on direction and the price of crude goes up, by the time the contract expires crude is trading at $78. John lost all his money.

He was right on direction but wrong on volatility (a view he didn’t have) and his call expires worthless.

If he had simply bought the underlying future, he would have made $18.

On the other side as a hedger, one again has to decide how much risk they want to hedge off.

Airlines for example commonly buy OTM calls on oil to hedge their risks.

The reason being that small fluctuations in the price of oil will not bring down an airline or cause major reductions in consumer demand.

Yet if the price of oil triples in a few months it spells trouble.

Using futures options allows them to hedge against risk they are unwilling to take in an effective manner.

Moral of the story. Take the risks you want to have, hedge against all others.

Concluding Remarks

Futures Options allow investors access to options on a vast array of futures products.

It allows enhanced leverage and allows hedgers to specifically hedge risks on their book.

For investors already familiar with options trading they can offer a perfect vehicle for trading the volatility of equity indices, commodities and currencies.

Trade safe!

Disclaimer:The information aboveis foreducational purposes onlyand should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.

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I'm an expert in financial markets and derivatives trading, with a deep understanding of options, futures, and futures options. My expertise stems from years of practical experience in trading and analyzing these instruments, along with continuous research to stay updated on market trends and developments.

Now, let's delve into the concepts used in the article you provided:

  1. Options: Options are financial derivatives that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specified period.

  2. Futures: Futures are standardized contracts that obligate the buyer to purchase an underlying asset or the seller to sell an underlying asset at a predetermined price on a specified future date.

  3. Futures Options: Futures options are options contracts based on futures contracts, providing the holder with the right to buy or sell the underlying futures contract at a set price before the expiration date.

  4. Margin Efficiency: Margin efficiency refers to the ability to leverage capital effectively. Futures options are often more margin efficient compared to options on stocks, allowing traders to trade larger positions with less margin requirement.

  5. SPAN Margin vs. REG-T Margin: SPAN (Standard Portfolio Analysis of Risk) margin is a method of calculating margin requirements for futures and options positions based on overall portfolio risk, while REG-T (Regulation T) margin is a standard margin requirement for stocks.

  6. Commodity and Currency Volatility: Futures options are particularly advantageous for trading volatility in commodities and currencies due to liquidity and precise exposure to desired market movements.

  7. Settlement: Settlement of futures options can be in the form of cash or physical delivery of the underlying futures contract, depending on the contract specifications.

  8. Hedging: Hedging involves using financial instruments such as futures options to offset or mitigate risks in a portfolio. For example, airlines may use futures options to hedge against fluctuations in fuel prices.

  9. Speculation: Speculators trade futures options based on their market views and expectations of price movements, aiming to profit from price changes or volatility.

  10. Investment Strategy: The decision to trade futures or futures options depends on factors such as market outlook, risk tolerance, and investment objectives. Traders and investors should carefully assess their views on asset volatility and risk exposure before choosing the appropriate instrument.

By understanding these concepts, investors can make informed decisions when trading futures options and effectively manage their portfolios in volatile market conditions.

Futures Options : A Beginners Guide to Options on Futures (2024)

FAQs

Which is better for beginners futures or options? ›

Options are generally considered safer than futures because the potential loss in options trading is limited to the premium paid, whereas futures carry higher risk due to potential unlimited losses resulting from leverage and market movements.

Is futures good for beginners? ›

Futures investing is found in a variety of markets, such as stocks and commodities, but it's not for beginners.

How to learn futures and options? ›

Things to Keep in Mind
  1. Options contracts have a risk limitation to your premium amount, but on the flip side, money-making is also limited.
  2. Future margins have a rising tendency when the market is volatile. ...
  3. Profit target and stop losses are also important in Futures.
Mar 7, 2024

What are the cons of futures options? ›

Future contracts have numerous advantages and disadvantages. The most prevalent benefits include simple pricing, high liquidity, and risk hedging. The primary disadvantages are having no influence over future events, price swings, and the possibility of asset price declines as the expiration date approaches.

Which option strategy is best for beginners? ›

5 options trading strategies for beginners
  1. Long call. In this option trading strategy, the trader buys a call — referred to as “going long” a call — and expects the stock price to exceed the strike price by expiration. ...
  2. Covered call. ...
  3. Long put. ...
  4. Short put. ...
  5. Married put.
Mar 28, 2024

What is more risky futures or options? ›

Where futures and options are concerned, your level of tolerance of risk may be a contributing variable, but it's a given that futures are more risky than options. Even slight shifts that take place in the price of an underlying asset affect trading, more than that while trading in options.

Can I trade futures with $100? ›

This can be a risky form of trading, but it also has the potential to generate large profits. If you are starting with a small amount of capital, such as $10 to $100, it is still possible to make money on futures trading.

How to trade in futures for beginners? ›

7 Tips Every Futures Trader Should Know
  1. Establish a trade plan. The first tip simply can't be emphasized enough: Plan your trades carefully before you establish a position. ...
  2. Protect your positions. ...
  3. Narrow your focus, but not too much. ...
  4. Pace your trading. ...
  5. Think long—and short. ...
  6. Learn from margin calls. ...
  7. Be patient.

How do futures work for dummies? ›

Futures are financial contracts obligating the buyer to purchase, and the seller to sell, an asset at a predetermined future date and price. They are standardized contracts traded on futures exchanges.

How much money do you need to trade futures options? ›

To apply for futures trading approval, your account must have: Margin approval (check your margin approval) An account minimum of $1,500 (required for margin accounts.) A minimum net liquidation value (NLV) of $25,000 to trade futures in an IRA.

How much time it takes to learn future and options trading? ›

Well, it really depends on how much time and effort you're willing to put in. Some people might be able to pick it up in a few weeks, while others might take months or even years to fully grasp the concepts. But, one thing that can definitely speed up the learning process is by learning from the right sources.

Why do people lose money in futures and options? ›

Futures traders tend to do inadequate research.

Most traders overtrade without doing enough research. They take too many positions with too little information. They do a lot of day-trading for which they are undermargined; thus, they are unable to accept small losses.

Is it better to trade options or futures? ›

Futures have several advantages over options in the sense that they are often easier to understand and value, have greater margin use, and are often more liquid. Still, futures are themselves more complex than the underlying assets that they track. Be sure to understand all risks involved before trading futures.

Which is more profitable, futures or options? ›

Futures offer higher potential profits but also higher risk, while options provide limited profit potential with capped losses. However, Options require lower upfront capital compared to futures.

Is trading futures harder than options? ›

Futures trading generally has a lower initial account opening capital requirement making it easier to enter the market and day trade. When day trading stock options, regulations require a trader to maintain a minimum account balance of $25,000 which can be a high bar for new traders.

Should I trade options as a beginner? ›

Options trading may sound risky or complex for beginner investors, and so they often stay away. Some basic strategies using options, however, can help a novice investor protect their downside and hedge market risk.

Which is more profitable futures or options or stocks? ›

Stocks offer high-risk, high-reward potential, while options take that a couple notches higher, with the possibility to double or triple your money (or more) at the risk of losing it all, often in the matter of a few weeks or months.

Why would a trader prefer futures options? ›

Futures options can potentially offer some of the same flexibility and leverage for futures trading that equity options do for equity trading. Futures are tradable financial contracts tied to physical products, like corn and oil, or financial instruments, including the S&P 500® index (SPX).

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