Understanding Futures Options

Let's understand how the futures options work...

Imagine you are walking past a second-hand car dealer. You see a car that you really like. However, you don't have the money on you to pay for the car, so you ask the second-hand dealer if it is okay to pay a deposit now, with the full purchase price payable in 30 days time. Luckily for you, the car dealer doesn't think there's a chance he'll sell that car a the mark price in the next 30 days, so he agrees to take your deposit on the understanding that you have to come back and see him with the full purchase price in 30 days time. You then go off and try and find the money. 

Of course, futures options are not confined to the world of second-hand motor cars, you'll also find they apply to almost any commodity and product that's available for sale today. 

Now, let's take our second-hand car dealer example a little further: 

The next day another potential buyer walks in and sees the car you've agreed to buy. They also really like it and want to buy the car. However, the second-hand car dealer has to tell the second potential purchaser that you already have an option to buy the car, which will elapse in 30 days. The new buyer says he cannot wait that long. Two options are now available:

(a) the second buyer walks away; or

(b) you agree to sell futures options you have over the car to the second purchaser. 

If we take the example one step further and say that the day following your down-payment the car manufacturer over the car you have an option announces they have a new model, thereby devaluing your car by 10% - what can you do about it? Nothing!

As you can see then, the world of futures options is all about picking winners and taking in a position in them. Waiting for the futures quote to go up and then either selling your position in the option to another buyer or waiting for the option to mature in order to take delivery of the product.

Trading futures contracts is risky and stressful indeed but trading certain strategies in an abnormal way will reduce your risk and increase your probability of profit by as much as 100%. Click here to find out more.