Futures Options
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Futures options may be described as the right to buy or sell a futures contract. Futures options, options on futures and commodity options are generally used interchangeably. Futures options are traded on regulated commodity exchanges such as the Chicago Mercantile Exchange (CME). The CME offers options on foreign currency products, equity products, interestrate products and livestock products.
Futures options are among the most versatile risk management products. They work as powerful tools to protect against the adverse price movements in commodity, interest rate, foreign exchanges or equity markets.
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Types of Futures Options
There are two kinds of futures options: put options and call options. A put option is the right to sell a futures contract. A call option is the right to buy a futures contract. The price at which these options are exercised is called the strike pricefor both put and call options. The different strike prices are set by the futures exchange. The premium of an option is determined by buyers and sellers reflecting supply and demand.
Users of Futures Options
The risk involved in hedging or speculating can be limited to the amount paid up-front. Consequently futures options have become increasingly popular among the hedgers and they are used by bankers, farmers, corporate treasurers, and equity portfolio managers throughout the world.
Pricing of Futures Options
The price that the buyer of an option pays to the seller of an option for the rights of that option is known as the premium. Factors affecting the options premiums may be strike price, time of expiration and market volatility. Intrinsic value for call options is calculated by futures price minus the exercise price. The breakeven point for a call option purchase is strike priceplus the call option premium.
Uses of Futures Options
Futures options can be used by speculators desiring to profit from a market move with limited risk. It is also used by the hedgers wishing to protect themselves against adverse price moves. To take advantage of a rising market, one could buy calloptions on futures.
Risks of Futures Options
It is advisable for sellers of futures options to be aware of the risks involved with taking short cuts or high risks while selling options as they can lose large sums of their trading capital.
