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Futures contracts are legally binding agreements to buy or sell a particular commodity or financial instrument at a later date. This commodity may be bushels of wheat or corn, or U. Buyers with long contracts are obligated to buy, and sellers with short contracts are obligated to sell, a specified amount of this commodity or instrument if they hold open futures positions on the delivery date. Options on futures are contracts that represent the right, not the obligation, to either buy go long or sell go short a particular underlying futures contract at a specified price on or before a specified date, the expiration date.
Note the difference, on the futures delivery date a physical commodity e. When or if option holders decide to actually buy go long the underlying futures contract, in the case of a call option, or sell go short the underlying futures, in the case of a put option, the right to do so must be exercised. This requires instructing their brokerage firm of their intention to exercise their long option contracts. This decision is totally up to the option holder. From whom do option buyers purchase these contracts and their inherent rights?
It is not from a corporation or an exchange. By doing so they are taking short positions that convey a potential obligation to take the opposite position of an option buyer.
When an option holder decides to exercise a long call or put, an option seller is assigned the obligation actually sell go short the underlying futures contract, in the case of a short call option, or buy go long the underlying futures, in the case of a short put option. Assignment is made on a random basis, and notice of assignment is made to option sellers by their brokerage firms. Option sellers do not determine whether or not they are assigned, nor do option buyers choose who is assigned when they exercise.
All options have an expiration date, after which the options cease to exist: There are two styles: Whether an option is American- or European-style depends on its contract specifications which are set by the exchange. For calls and puts, the actual cash paid by an option buyer to the option seller is called the premium. It is an amount measured in U. For an option buyer, call or put, the premium paid is nonrefundable. To recover any or all of the premium amount the option may be sold in the marketplace if it has value.
An option seller keeps the premium amount initially received whether or not the short contract is assigned.
The specified price at which an underlying futures contract will change hands after an exercise or assignment is called the strike price, also referred to as the exercise price. When a call is exercised, the buyer will buy go long the underlying future from the assigned call seller at the strike price, no matter how high its current market price may be.
When a put is exercised, the buyer will sell go short the underlying future to the assigned put seller at the strike price, no matter how low its current market price may be.
In the marketplace the range of available strike prices, and the intervals between them, vary depending on the underlying futures contract. There will be strike prices set above and below an existing futures price. Additional strikes are added by the exchange if needed as the market value of a futures contract moves up or down. September Japanese Yen futures are trading at Available call strike prices might be , , , and If the futures price rises to you might find higher strike prices of and made available.
If the futures price drops to you might find lower strike prices of and made available. A call or put is at any given time either in-the-money, at-the-money or out-of-the-money, and as the market price of an underlying futures contract changes this condition is dynamic. One way to look at this is to consider whether at any moment an option might be worth exercising.
If the underlying E-mini future is trading at , the call holder has the right to go long the future 20 points less than its current value. Is it worth exercising or not? If the underlying E-mini future is trading at , the call holder has the right to go long the future 20 points more than its current value.
A call guarantees its buyer a fixed purchase price, the strike price, for the underlying futures contract, if the call is exercised. As the futures price rises that purchase price is worth more to a buyer so the call option increases in value. The opposite is true for a call if the futures price declines. A put guarantees its buyer a fixed selling price, the strike price, for the underlying futures contract, if the put is exercised.
As the futures price declines that sale price is worth more to a buyer so the put option increases in value. The opposite is true for a put if the futures price increases. Calls and puts on the same underling futures contract with the same expiration month will have a range of available strike prices. Again, standardized strike prices are set and specified by the option contract. The time value portion of call and put premiums decreases over time. This is referred to as time decay. The rate of decay is not linear, it increases as expiration approaches.
Volatility is a function of price movement of an underlying futures contract. Precisely, it is a measurement of price fluctuation up or down, not a sustained upward or downward price trend. Call and put buyers want more volatility and are willing to pay more premium for it.
Call and put sellers want lower volatility, i. They require more premium for the inherent risk of higher volatility levels. Many investors buy calls or puts with no intention of exercising into a long or short underlying futures position. Instead they make an offsetting transaction to take a profit or cut a loss. Offsetting a call position in no way involves a put transaction, and vice versa. Once a long position is offset a call or put buyer is out-of-the-market and no longer has rights to exercise and buy for a call or sell for a put the underlying futures contract.
Once a short position is offset a call or put seller is out-of-the-market and assignment is avoided. The seller no longer has the obligation to buy for a call or sell for a put the underlying futures contract. The information herein has been compiled by CME Group for general informational and educational purposes only and does not constitute trading advice or the solicitation of purchases or sale of any futures, options or swaps.
All examples discussed are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. The opinions expressed herein are the opinions of the individual authors and may not reflect the opinion of CME Group or its affiliates. Current rules should be consulted in all cases concerning contract specifications.
Although every attempt has been made to ensure the accuracy of the information herein, CME Group and its affiliates assume no responsibility for any errors or omissions.
All data is sourced by CME Group unless otherwise stated. All other trademarks are the property of their respective owners. Neither futures trading nor swaps trading are suitable for all investors, and each involves the risk of loss.
Futures and swaps each are leveraged investments and, because only a percentage of a contract's value is required to trade, it is possible to lose more than the amount of money deposited for either a futures or swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles and only a portion of those funds should be devoted to any one trade because traders cannot expect to profit on every trade.
Sign In Sign Up. July Soybeans Call. July Euro FX 1. September Japanese Yen Call. Strike Price index points. Strike less than futures price. Strike greater than futures price.
Strike same as futures price. Time until Expiration Increases. Call and Put Prices Increase. Time until Expiration Decreases. Call and Put Prices Decrease. Effect of time on time value only. CALL prices greater with more time. CALL prices decrease with higher strikes. Sep Yen Call. Oct Yen Call. PUT prices greater with more time. PUT prices increase with higher strikes. Sep Yen Put.
Oct Yen Put. Effect of volatility on time value only. Buy call long position. Buy put long position.