Futures options are a low-risk method to invest in futures markets. Many novice traders begin by trading futures options rather than plain futures contracts. When opposed to futures contracts, buying options carries less risk and volatility. Many expert traders trade options solely. Before you can trade futures options, you must first comprehend the fundamentals.
Futures Options
A futures option is the right, but not the duty, to purchase or sell a futures contract at a specified strike price at a certain period. Purchasing options enables a trader to bet on price fluctuations in a futures contract. Buying call or put options does this.
A call option buy is a long position, a wager that the underlying futures price will rise. For example, if one anticipates that corn futures will increase, they may purchase a corn call option. Conversely, a put option buy is a short position or a wager that the underlying futures price will fall. For example, if one anticipates soybean futures to fall, they may purchase a soybean put option.
Important Keywords
- Contract Months (Time): All options have an expiry date and are only valid for a certain period of time. Options are squandering assets; they do not endure indefinitely. A December corn call, for example, ends in late November. Option positions need special care since they are assets with a short time horizon. The longer the period of an option, the higher the cost. The term part of its premium represents the time value of an option.
- Premium: The buyer is responsible for paying the premium, while the seller keeps this money as payment for the option. When it is less probable that an option will move to the strike price, the absolute cost of that option will be lower, but when it is more likely that an option will move to the strike price, the cost of the derivative instruments that are based on that option will increase.
- Strike Price: The price at which a futures contract's underlying futures contract may be purchased or sold is referred to as the strike price. Take into account the following: The difference between the current market price and the strike price functions similarly to the deductible that is required for various types of insurance.
Purchasing An Option
If you believe the price of gold futures will rise in the next 3 to 6 months, you should buy a call option. Purchasing an option is the same as purchasing insurance, and the value of an asset will rise. Conversely, purchasing a put option is the same as purchasing insurance in that the value of an asset will decline.
When you purchase an option, your risk is limited to the premium you pay. Selling options is the same as operating as an insurance business. You can only earn the premium you first received when you sell an option. After that, the possibility of loss is limitless. Because options behave identically over time, the optimal hedge for an option is another option on the same asset.
Wrapping Up
Contrary to popular belief, futures and options trading is not as complex as it may seem. You'll use these cutting-edge financial products better if you have a proper understanding of them, no doubt about it! Having a Demat and trading account is crucial whether you're trading derivatives or making investments in upcoming IPOs. If you don't already have one, head over to Motilal Oswal right now to open a free Demat account and trading account.
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