Futures options can be a low-risk way to approach the futures markets. Many new traders start by trading futures options instead of straight futures contracts. There is less risk and volatility when buying options compared with futures contracts. Many professional traders only trade options. Before you can trade futures options, it is important to understand the basics.
According to Nasdaq's options trading tips, options are often more resilient to changes (and downturns) in market prices, can help increase income on current and future investments, can often get you better deals on a variety of equities and, perhaps most importantly, can help you capitalize on that equity rising or dropping over time without having to invest in it directly.
The purchase of a call option is a long position, a bet that the underlying futures price will move higher. For example, if one expects corn futures to move higher, they might buy a corn call option. The purchase of a put option is a short position, a bet that the underlying futures price will move lower. For example, if one expects soybean futures to move lower, they might buy a soybean put option.
When a trader buys an options contract (either a Call or a Put), they have the rights given by the contract, and for these rights, they pay an upfront fee to the trader selling the options contract. This fee is called the options premium, which varies from one options market to another, and also within the same options market depending upon when the premium is calculated. The option's premium is calculated using three main criteria, which are as follows:
Investing with options— an advanced trader will tell you— is all about customization. Rewards can be high — but so can the risk— and your choices are plenty. But getting started isn’t easy, and there is potential for costly mistakes. Here’s a brief overview of option trading that cuts through the jargon and gets right to the core of this versatile way to invest.
An option's price, its premium, tracks the price of its underlying futures contract which, in turn, tracks the price of the underlying cash. Therefore, the March T-bond option premium tracks the March T-bond futures price. The December S&P 500 index option follows the December S&P 500 index futures. The May soybean option tracks the May soybean futures contract. Because option prices track futures prices, speculators can use them to take advantage of price changes in the underlying commodity, and hedgers can protect their cash positions with them. Speculators can take outright positions in options. Options can also be used in hedging strategies with futures and cash positions.
With this strategy, the trader's risk can either be conservative or risky depending on their preference (which is a definite plus). For iron condors, the position of the trade is non-directional, which means the asset (like a stock) can either go up or down - so, there is profit potential for a fairly wide range. To use this kind of strategy, sell a put and buy another put at a lower strike price (essentially, a put spread), and combine it by buying a call and selling a call at a higher strike price (a call spread). These calls and puts are short.
Decide whether you think a commodity will sell for more or for less at some designated time in the future, then buy either a “put” or a “call” option. For example, you think that corn will cost more three months from now than it does now, so you will buy a “call” option on 100 bushels of corn which, in effect, locks in the cost of that commodity. Before the option expires, hopefully the price will go up, so your option will be worth more. Conversely, you will buy a “put” option if you think the price of the commodity will be less than it is today.
If a company locks in the price and the price increases, the manufacturer would have a profit on the commodity hedge. The profit from the hedge would offset the increased cost of purchasing the product. Also, the company could take delivery of the product or offset the futures contract pocketing the profit from the net difference between the purchase price and the sale price of the futures contracts.
Remember, a stock option contract is the option to buy 100 shares; that’s why you must multiply the contract by 100 to get the total price. The strike price of INR 300 means that the stock price must rise above INR 300 before the call option is worth anything; furthermore, because the contract is INR 10 per share, the break-even price would be INR 310(INR 300 + INR 10).
So, call options are also much like insurance - you are paying for a contract that expires at a set time but allows you to purchase a security (like a stock) at a predetermined price (which won't go up even if the price of the stock on the market does). However, you will have to renew your option (typically on a weekly, monthly or quarterly basis). For this reason, options are always experiencing what's called time decay - meaning their value decays over time.