Options on futures are derivative products that trade on futures exchanges. The two most recognized exchanges within the United States are the Chicago Mercantile Exchange and the IntercontinentalExchange. These exchanges allow customers who trade through clearing members to trade futures and options on futures.
A futures contract is the obligation to purchase a specific underlying product or index on or before a specific date. Futures settle on a physical or cash basis. A physically delivered futures contract requires that the buyer except delivery of the underlying product on any date after the delivery date. For example, an investor who purchases a futures contract on physically delivered WTI crude oil must take delivery in Cushing, Oklahoma, if he owns the futures contract after the delivery date. An investor can avoid physical deliver by exiting -- selling -- a futures position prior to the delivery date. A cash-settled futures contract exchanges money after the settlement date.
A call option on futures contract is the right but not the obligation to purchase a futures contract at a specific price on or before a specific date. The price at which the purchaser of a call option has the right to buy the underlying futures contract is called the strike price. The date on which the option expires is called the expiration date. A European-style call option gives the purchaser of the option the right to exercise the call option on the expiration date; an American-style call option give the purchaser of the option the right to exercise the option at any time prior to and including the expiration date.
Who Can Buy Futures Options
Futures and options on futures are transacted on regulated exchanges. The exchanges allow their clearing members to transact for themselves and their clients. To buy an option on a futures contract, you must either be a clearing member or have a brokerage relationship with a clearing member.
Futures Options Brokers
Futures brokers offer numerous types of client relationships, from full service advice and execution to discounted online services. A broker requires a client to fill out an application and apply for futures and options margining. Margining allows a brokerage client to borrow money and is the standard used by regulated futures exchanges. Without a relationship with a regulated broker, individuals cannot purchase futures options.
David Becker is a finance writer and consultant in Great Neck, N.Y. With more than 20 years of experience in trading, he runs a consulting business that focuses on energy hedging and capital market analysis. Becker holds a B.A. in economics.