What Are Options on Futures & How Do They Work?
Futures options can be a low-risk method to getting exposure to the futures market. Trading options on futures works like trading options on individual equities but rather than the underlying asset being a stock, it’s a futures contract.
In addition, there are other key differences for investors to bear in mind, including how futures are traded.
It is important to be aware of these differences, and familiarize yourself with key terms and understand how futures options work for buyers and sellers.
What Are Options on Futures?
Options on futures allow you to make bets on futures contracts with lower capital requirements than the futures themselves, which is in turn lower than the capital required to trade in the assets underlying the futures. Instead, puts and calls are used.
Recommended: How to Trade Options
Key Terms to Know About Futures Options
Experienced options traders might be familiar with many of the primary terms of options on futures. New traders should understand these basics. Let’s investigate some key terms.
Premium
Premium is the amount you pay for calls and puts when you buy these instruments. Options sellers collect the premium at the initiation of a trade. The amount of premium paid or collected is determined by a variety of factors including the size of the underlying futures contract.
The lower the premium, the less the market believes a futures contract will be in-the-money by expiration.
Contract Months
Unlike stocks, options contracts have expiration dates. When trading options on futures there are two expiration dates to keep in mind: the expiration date of the futures option and the expiration date of the futures contract.
Options on futures pricing usually expire near the end of the month before physical delivery of the futures contract takes place.
In general, the longer the time until expiration, the more expensive the options will be.
Strike Price
The strike price on futures options is the price at which you can buy or sell the underlying futures contract.
For example, when you buy a call option on a futures contract with a strike price of $10, you have the right, but not the obligation, to buy the underlying futures contract at $10 on or before expiration for an American-style option.
Many futures options contracts are European-style, however, which means they can only be exercised on the expiration date and not before.
Most options are not exercised, rather they are closed in the market before expiration.
How Do Futures Options Work?
Futures options work very much like options on equity securities, but there are differences.
Let’s outline some of the specifics so you understand the mechanics of trading options on futures contracts.
Calls and Puts: Rights for Buyers
The buyer of a call option on a futures contract has the right to buy the underlying futures contract at a predetermined price and time. The buyer of a put option on a futures contract has the right to sell the underlying futures contract at a predetermined price and time.
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Calls and Puts: Obligations for Sellers
The seller, or writer, of a call option on a futures contract is obligated to sell the underlying futures contract at a predetermined price and time. The seller of a put option on a futures contract has the obligation to buy the underlying futures contract at a predetermined price and time.
Be aware that most options on futures are cash-settled. That means the price difference is paid or received — there is no physical delivery of the futures contracts or assets with cash-settled options.
💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.
Pros and Cons of Options on Futures
Options and futures have benefits and drawbacks. Let’s clarify some of those.
Pros
A primary advantage of options on futures is that you can trade with high leverage. This means you put down a small amount of capital to access a large notional value of an asset. Small swings in price can lead to large moves in your account’s equity.
Another upshot is the options market on futures is open more hours than the stock market. You can trade overnight in many markets.
When you purchase options, the most you can lose is the premium you pay. When you sell options, you know what your max gain is: the premium received. For this reason, options on futures can be used to tailor an investment strategy based on your risk and reward objectives.
Cons
There are downsides to consider. For example, when you trade with high leverage, you expose yourself to a large loss potential.
You must also be aware of differences in options specifics in futures trading. For example, a $1 move on a futures index option could have a much greater impact on your account’s equity versus a $1 move on an equity option.
Finally, futures contracts are more complex than equity options. Each futures contract has unique specifications. It can be tough to understand all the futures contracts available to trade.
American-Style vs European-Style
| American-Style | European-Style |
|---|---|
| The holder can exercise before expiration | The holder cannot exercise before expiration |
| Most options on equities are American-style | Futures contracts often have European-style options |
| Quarterly options on S&P 500 futures contracts, Eurodollar options, and Treasury options | Most CME Group options on futures are European style |
There is a third less common option, the Bermudan option. Bermudan options lie somewhere between American and European options — hence the name. The biggest difference is Bermudan options can be exercised on specified dates prior to expiration. These dates are laid out in the options contract.
Option Value vs Underlying Futures Value
The price impact on a futures option works just as options on stocks. Calls benefit from higher prices on the underlying asset while puts rise when the underlying price drops, all else equal.
| Futures Price Change | Call Price Change | Put Price Change |
|---|---|---|
| Increase | Increase | Decrease |
| Decrease | Decrease | Increase |
In-the-Money vs At-the-Money vs Out-of-the-Money
It is important to understand the moneyness of options when trading. Moneyness is simply the difference between an option’s strike price and the underlying asset’s price. Knowing the moneyness of an option can help you decide whether to exercise.
In-the-money options have intrinsic value and are priced more expensively than out-of-the-money options. Out-of-the-money options are often cheaper and can be accessed with a smaller amount of capital.
| In-the-Money | At-the-Money | Out-of-the-Money |
|---|---|---|
| For calls, when the underlying asset’s price is above the strike | For calls, when the underlying asset’s price at the strike | For calls, when the underlying asset’s price is below the strike |
| For puts, when the underlying asset’s price is below the strike | For puts, when the underlying asset’s price is at the strike | For puts, when the underlying asset’s price is above the strike |
Examples of Futures Options
You can find examples of futures options on many types of futures contracts. Stock market indexes and commodities are two markets that have options available to trade. Interest rate and foreign exchange markets also have futures markets with options. You can construct options strategies in these markets including defined-risk plays such as a collar in options.
The Takeaway
Options on futures allow investors to make bets on futures contracts with lower capital requirements than the futures themselves, which is also lower than the capital they’d need to trade the underlying asset. Instead, puts and calls are used.
So in that case, an option on a futures contract gives the holder the right, but not the obligation, to buy or sell a futures contract at a predetermined price usually on a pre-specified expiration date. Trading options and futures is a low risk way to access the futures market.
Qualified investors who are ready to try their hand at options trading, despite the risks involved, might consider checking out SoFi’s options trading platform. The platform’s user-friendly design allows investors to trade through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.
Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors.
FAQ
Can you trade options on futures?
Yes, you will need to open an account with a broker that offers this type of trading. There might be high capital requirements to meet in order to open an option on a futures trading account.
How do you buy futures?
Futures contracts can be bought through a futures trading brokerage company or directly at an exchange. Most retail traders go through a brokerage company. Not all brokerage firms offer these products, however.
What is the difference between futures and options?
Futures obligate the buyer to purchase an asset and a seller to deliver that asset unless the option buyer’s position is closed by the expiration date.
Options give the buyer the right, but not the obligation, to buy or sell an asset at a specified price during the life of a contract, while potentially creating an obligation for the seller (of the option) to buy or sell the underlying asset if the buyer exercises that option.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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