Options on futures are powerful derivative instruments which offer a unique way to speculate futures markets. Futures options can be an effective way to broaden and balance market exposure while diversifying a trader’s portfolio.
Similar to stock options, futures options have distinct vocabulary and concepts to understand. Commonly used in options trading, the terms in the money and out of the money are important to understand in relation to what type of option is being bought or sold.
There are two types of options on futures: call and put options. Call options give you the right to buy the underlying futures contract before the option expires and put options give you the right to sell the underlying contract before the expiration date.
Call Options: In the Money & Out of the Money
When holding a call option, traders anticipate the underlying market to rise in value. For call buyers, in the money refers to the area above the strike price and out of the money refers to the area below the strike price.
An in the money call option provides the option holder the opportunity to buy the underlying contract below its current price and can therefore sell the call option for a profit. An out of the money call option means the holder has an option to buy the underlying contract at a price above its current level.
Put Options: In the Money & Out of the Money
Conversely, with puts, in the money and out of the money are reversed from calls. When holding a put option, traders anticipate the underlying market to decline in value. This is similar to a short trade where profits are made by the price of an asset moving down.
A put futures option is considered in the money when the price of the underlying futures contract is below its strike price. This gives the put holder the right to sell the underlying contract above its current price and can therefore sell the put option for a profit. An out of the money put option means the holder has an option to sell the underlying contract at a price below its current level.
Please note that if you are buying calls or puts, you are expecting the market to move in the money. Selling options will always be betting on a market moving out of the money.
Although options trading can be a way to balance market exposure, speculative trading of options on futures involves risk and traders should always employ proper risk-management measures.
Learn more about Options on Futures in this short video overview:
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