Get to Know Underlying (Options on Futures)

Option contracts are written on a broad cross section of underlying futures contracts. Since 1982, when option contracts on futures were first introduced, the options market has grown significantly and now most major US futures contracts have companion option contracts. Very few new futures contracts are listed on major exchanges without an associated option contract. Hedgers and speculators alike spend a great deal of time examining price behavior unique to each underlying futures contract. Historic price data along with other statistics, such as open interest, volatility, delta, etc., are useful in choosing the strike price and time frame for an option contract.

CME Group is the world’s largest Derivatives Exchange. In 2016, average daily volume reached a record 15.6 million contracts and open interest exceeded a record 120 million contracts.

Both futures and options on futures are called derivatives because they “derive” their value from something other than themselves. For example, a corn futures contract derives its value from the actual underlying corn that can be delivered into the contract.

An option on a future is no different in this regard, but the underlier is another derivative, namely the corn future, which in turn has actual corn as its underlier.

Option contracts span a variety of asset classes, including Interest Rates, Equity Indexes, Foreign Exchange, and physical commodities.

Each option you hold is either the right to buy (call option) or the right to sell (put option) an underlying futures contract as defined by the name of the underlying commodity, index, or interest rate future on which the option is based.

For example; 

• If you are holding a Gold option on a commodity future, you will have the opportunity to either buy, in the case of a call, or sell, in the case of a put, a Gold futures contract at a specific price on or before the expiration of that contract.
• If you are holding an S&P 500® Equity Index option, then you have the opportunity to either buy or sell a future, at a specified price, on the S&P 500®-index level for a defined period of time.
• When holding a Treasury option, you have the right to buy or sell a $100,000 US Treasury bond futures contract at a specific price during a certain period of time.

In each case, the underlying contract influences the value of the option: the strike range, the premium, and the timing for each option.

Doing your homework on the underlying futures contract, may help you identify opportunities in the associated options contracts.