Pricing Futures Options
Jan0
Many traders who understand futures trading have a hard time understanding futures options. This is because the pricing of the options is sometimes different for the futures option contracts compared to the futures contracts.
For example, the 30 year t-bond futures contract has 32 ticks for each point in t-bonds. Each tick is worth $31.25. Now the options have 64 ticks in every point. Each tick in options is worth $15.625. See how this is confusing. Not every market is like this. The financials have markets like this as discussed with bonds and also the grains.
For instance wheat futures are priced at $50 per cent. Each tick is ¼ cent. So each tick in wheat futures is $12.50. In the options market there are 8 ticks in each cent. So each tick is 1/8 cent and each tick is $6.25. We purchase or sell options while looking at the underlying contract. The underlying contract might be priced differently so that is why it can get confusing.
Keep this is mind when buying or selling any options and futures. You would notice the prices are different if you check the quotes in the futures market compared to the options market.
For bonds I might see that bonds are priced at 115-31. I then look at an option and it is priced at 1-32. Now you will notice that bonds are never priced above -31 because there are 32 ticks and the next tick after 31 ticks is one point. So after 115-31 the next price is 116. In bonds options as we have seen, the price of the option can go from 1-31 to 1-32 because there are 64 ticks in every point in the bond markets.
For wheat you can see futures at 5546 which is 554 and ¾ or 554.75. Three quarters happens to be the highest price for futures ticks. You might see an option contract for wheat priced at 9-7 which is 9 and 7/8 which is 9.875.
So remember this when you are comparing futures options prices with futures prices.
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Futures Options and Spreads
Jul0
Please only use these future option examples for educational purposes.
Paper trade them.
I normally write about spread options. Today I want to first take a look at a futures spread. Let’s look at a natural gas/heating oil spread. This is buying one natural gas futures and selling one heating oil futures.
Below are daily, weekly and monthly charts:
Daily
http://deltaneutraltrading.com/062709.bmp
Weekly
http://deltaneutraltrading.com/062709b.bmp
Monthly
http://deltaneutraltrading.com/062709c.bmp
You can trade this as a spread using options. You do not have to just buy and sell the futures. You can buy a call and buy a put instead so you are limited in your potential loss. Even though futures spreads can have less risk, there is still the possibility of unlimited losses.
With buying options, you are limiting the risks. You no longer have unlimited loss potential. But the problem is that you are buying premium. So instead of just buying options, you can buy and sell credit spreads.
For example, from looking at the above chart, we can buy an at the money natural gas call option and sell a natural gas out of the money call. Then we sell an at the money heating oil call option and buy an out of the money heating oil option. We expect the natural gas futures to rise in comparison to the heating oil futures because of the chart.
I go over these types of option spreads in my course. And I look at some market combinations that you might not have thought of. Don’t just use these for the obvious spread markets like, wheat/corn, t-bond/t-note. There are other market combinations for spreads and other ways to come up with the option spreads. You can create a spread using more than one market instead of just two markets. You can also create option combinations that are not typical credit or debit spreads. Think outside the box with commodities options.
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Futures Option Spreads
Jun0
There are many ways of trading in the futures commodity markets. One way is to trade options on futures. There are many strategies you can use in trading futures options. You can just buy an option or just sell an option. You can also put on what is called a spread using options. Spread options are when you buy and/or sell more than one option at a time in the same order.
You can buy 2 options or sell 2 options or buy one option and sell another option. The options you buy have to be in a different strike price to be considered a spread. If you just purchased 2 of the same options, that would not be a spread. The 2 options would have to be 2 different future option contracts. Let’s look at corn. These are not current prices but just an example. If I purchased 2 $3.00 corn options, that would not be a spread. If I purchased one $3.00 corn option and sold one $3.10 corn option, that would be a spread. I would put this trade on in one order.
Not all spreads have to be in the same contract month or even the same market. When putting on a spread in different months, you could put in an order to buy one option in one month and sell another option in another month at a certain price. These are called calendar spreads as they involve different months.
Now when putting on a spread, you will either have money coming into your account or going out. If your purchased options cost more than the sold options, you would state that you are putting it on for a debit. If you are taking in more with the sold options than you are paying with the purchased options, you are putting the spread on for a credit. I will discuss other types of options strategy using spreads in another article.
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Commodity Markets Trading With Technical Analysis
Jun0
Commodity trading and futures option trading is best done with the help of technical analysis. Technical analysis shows a trader the direction; he should take while dealing with commodities. Whether one should buy or sell is best determined with the help of Technical Analysis. A good trading system will always incorporate methods used in TA within itself.
Technical Analysis Defined
The process of determining the condition of a commodity (based on the historic price) with the help of charting is called Technical Analysis. It combines probability mathematics and statistical information to determine the future price movement of a commodity with probability on your side. For example, if someone were to walk up to a door, and you were told to guess which direction they would go – left or right, whatever you chose, it would be speculation. On the other hand, if they went left, and you followed them, that would be called trend following. Similarly, if a commodity future moves in a direction and you use TA to guide you, you can buy it after it shows a move into a certain direction, and a trend has been confirmed.
Uses Of Technical Analysis
There are many ways TA helps traders in trading futures options and commodities. The primary principle in TA is to have the ability to follow trends. To be able to do this, one has to be able to catch it early enough. So, you can buy into a commodity if you can confirm that it is in an uptrend. The key point to remember is that TA assumes that price discounts everything.
All movements of market participants are reflected in the price of any commodity at any given point in time. The idea is to buy low and sell high, or vice versa. This sounds simple in theory, but is difficult enough in real life. Imagine knowing that the probability of a commodity will breakout on the upside, but also that it is only a probability, and not a surety.
How Do We Use Technical Analysis?
TA has many different theories. These include common theories and indicators such as moving averages, Fibonacci series, oscillators, Gann Trading theory, Elliot wave theory, and the age-old Candlestick theory from Japan. Many users tend to combine one or more of these theories to get greater accuracy in determining the trend more correctly in their favor. One has to remember that probability needs to be on our side.
The risk to reward ratio should always be in our favor. A lot of people use TA to help them establish a trend, get the point of a breakout and look for a point to buy or sell a commodity. They also use it to determine their stop-loss, and possible target price. This is an advantage that TA has over any other form of analysis. Being mathematical in nature, it gives you exact figures as to what levels you need to enter and exit a commodity.
Technical Analysis is a powerful tool that needs to be executed with care and discipline. It provides the right foundation you need to determine the price trend of a commodity with more accuracy.
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Risks in Futures Options Trading
May0
When people speak of future option or commodity option trading, they think of the risks involved. There are risks involved when buying and selling options. When buying an option, the risk is how much you paid for the options. There is limited risk involved in buying an option. In selling futures options, there is unlimited risk involved because if the option goes “in the money” you have the potential for unlimited loss.
For example, if the underlying futures market was trading at 3.00 and I sold a 3.50 call option, this option is not yet in the money. It is “out of the money”. If the futures hits 3.50, then the option is “at the money”. Once it goes beyond 3.50, it is in the money. If I sold the commodity option and the futures eventually goes to 5.50, then it has 2.00 worth of “real value” or intrinsic value. So we can lose more than we expected. Some people only buy options for this reason.
When buying futures options though, you are paying premium and this is risk as well. The chance that you will be in the money and recover your premium payment is the risk involved. There is unlimited potential with limited risk. But the disadvantage is that the options usually expire worthless. Leverage is the reason people buy futures options. You can control the underlying futures with a smaller investment and less risk than by buying or selling the futures contract. I am paying a premium to do this and I am also trading time as well. Meaning, I only have until the option expires to be correct, so time is a factor in futures options trading also.
Futures options sellers are trading the fact the an option will not be profitable for the option buyer before a certain time frame. Hopefully the futures option will expire worthless or lose money before the option expires.
I will write about different techniques in another article. There are many ways to trade futures options. You can buy an option or sell an option or you can put on a credit spread where you do both.
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