Options on futures are versatile securities which present 4 unique ways to speculate and trade futures markets. While other vehicles such as stocks and futures offer the 2 options of buying or selling (shorting) based on a bullish or bearish bias, options on futures provide 4 unique market entry choices and greater risk control.
With options on futures, you have an additional level of order versatility built around buying or selling calls and puts.
1. Buy Call Options
With regard to options on futures trading, a call is the right to buy the underlying futures market at an agreed upon price on or before the expiration date. For example, if you buy a call of the E-mini S&P 500, you are buying the right to buy the ES at a fixed price in the future before the options contract expires.
Buying call options is like putting a down-payment on a piece of property for the right to buy that property at a locked-in price before a specified date. Call options buyers, or holders, anticipate a rise in value in the underlying asset before the expiration date.
2. Sell Call Options
It is also possible to sell calls. In this case you would be selling the right to buy the underlying market at that locked-in price. Call option sellers, known as writers, sell call options in hope that the underlying market loses value before the expiration date.
3. Buy Put Options
A put is the right to sell the underlying market at an agreed price before the expiration date. Put holders (buyers) anticipate a decrease in value of the underlying futures vehicle.
Buying put options can be thought of as buying an insurance policy to protect your assets in a bearish market.
4. Sell Put Options
When writing puts, traders sell put options in anticipation of a rise in value of the underlying futures vehicle. A put writer sells the put option to the put holder in exchange for the options premium.
Risks Involved in Trading Options on Futures
Before buying or sell any options, you will want to better understand the behavior, benefits, and risks unique to each trade.
- Limited Risk for Buyers: When you buy a call or put, there is limited risk. You are buying the right, not the obligation to buy or sell. Essentially, options holders know the risk of their trade at market entry. An options buyer is not risking any more than the options premium, plus commissions and fees which can be advantageous for new traders looking to limit their risk.
- Unlimited Risk for Sellers: While buyers experience limited risk, sellers are exposed to unlimited risk as they could incur losses much greater than the price of the contract. When you write a call or put, you are obligated to buy or sell shares at a specified price within the contract’s time frame, even if the price does not move in your favor!