Chances are, you know about options. You may also have heard of futures. But have you heard of futures options?
Futures options can sometimes offer traders the best of both worlds for certain products.
This article will break down what futures options are. We will then examine some of the benefits and times to use them in a portfolio.
A futures option is an option on a futures contract that gives the holder the right to buy or sell a particular asset for a specified period of time at a specified price.
If this sounds similar to an options contract, it’s because they are almost the same.
For example, a futures call option does the same thing Exposure to Greeks the A Call option on a share would have.
To be long delta, gamma and vega while you’re short theta.
Well, if you Experience with options, branching into futures options is not difficult.
The main difference is that in this case the underlying is not a stock or an ETF, but a futures contract itself.
1. You are more margin efficient
The biggest benefit of trading futures options is access to greater leverage through SPAN margin.
This allows option sellers to trade significantly more money than is available from Put options on stocks as this uses the Reg T margin.
Below is an example of the margin requirement for selling a futures options put money on an ES contact.
We can see that by selling this ES Put we are getting a credit of $ 1,275 (in yellow) and needing to provide $ 11,112 in Initial Margin (in red).
Now let’s compare this to selling 5 SPY puts, which is the same face value as our One ES Futures option.
Here we have the same credit and the same risks.
We sell the same face value on the S&P 500.
Even so, we have a shocking margin of $ 62,516 to provide!
This is all due to the calculation of SPAN vs. REG-T, not the real risk.
In this case, The superior margin efficiency below the SPAN margin makes selling the ES option a much better bet.
2. Futures options are superior in terms of the volatility of commodities and currencies.
To trade volatility on currencies and commodities other than gold, silver and oil, it is almost necessary to trade the futures options.
This is because the ETFs that track these products are few and illiquid.
For example, if a trader wanted to trade soybeans as the largest ETF, SOYB only has $ 100 million in assets and relatively illiquid options.
This makes trading difficult.
In contrast, soybean futures and options are liquid, margin efficient, and allow investors to get the exact exposure they want.
The simple answer is no.
It only allows traders to apply more leverage.
When you have two trades with positive expected value, applying higher leverage will increase profitability.
Unless you have an advantage in your trade, adding leverage will not increase profitability.
If anything, you will only end up losing money faster.
One of the most confusing things about futures options is the settlement.
Regular options on stocks and ETFs involve settlement by buying or receiving the specified number of stocks if the contract ends in the money.
For stock futures Options settlement is usually related to the underlying futures contract or simply cash. As can be seen from the ES billing details below.
We see here the options for all major quarterly maturities that are settled in cash while other maturities are settled on the upcoming futures contract.
In the event that the futures option is settled in cash, no further action is required.
If it is settled on the underlying future, you simply buy or sell the future position upon allocation or close the option position before allocation to the future.
In contrast, most commodity and currency futures require physical delivery.
If you’re reading this article, you probably don’t have the capacity or permission to store 1,000 barrels of oil in your yard!
Therefore, you are forced to close out a position prior to settlement and delivery.
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If you want to keep your exposure, you can simply build a new options position in the next futures cycle.
If you forget to close the position after a few reminders from the broker, your position will be liquidated.
This is usually not the end of the world as liquidity is generally good.
In order to decide whether to trade futures or futures options, it is important to determine your perspective on the asset that you want to trade.
If, as a speculator, you do not have an eye on the volatility of the instrument you are trading, it is almost always better to trade the underlying asset.
This applies to stocks vs. options.
The same applies to futures and futures options.
The reality is that the futures contract will always be more liquid than the futures options.
When a trader buys or sells future options, he brings all of the Greeks into the equation.
Imagine if John is optimistic about the price of oil.
The May crude contract is trading at $ 60, so it buys the $ 80 call for $ 1.50.
John is heading in the right direction and the price of crude is rising, and by the time the contract expires, crude will be trading at $ 78. John lost all his money.
He was right about that, but wrong about that volatility (an opinion he didn’t have) and his call expires worthless.
If he had just bought the underlying future, he would have made $ 18.
On the other hand, as a hedger, you have to decide how much risk you want to hedge.
For example, airlines often purchase OTM calls on oil cover their risks.
The reason for this is that small fluctuations in the price of oil will not bring down an airline or greatly reduce consumer demand.
But if the price of oil triples in a few months, it means trouble.
With futures options, you can effectively hedge against risks that you do not want to take.
Moral of the story. Take the risks you want to take and hedge against everyone else.
Futures options give investors access to options on a wide range of futures products.
It allows for improved leverage and enables hedgers to hedge risks in their book in a targeted manner.
For investors already familiar with options trading, they can provide a perfect vehicle for trading the volatility of stock indices, commodities, and currencies.
Disclaimer: The information above is for For educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are unfamiliar with exchange-traded options. All readers interested in this strategy should do their own research and seek advice from a licensed financial advisor.