An Introduction to Futures Options
There are numerous ways a trader can protect himself in forex trading. Just as hedging can shield currency speculators, so can futures options serve as insurance for those trading in the futures market.
A futures contract, in plain and simple terms, involves a financial agreement between two entities, wherein one will buy or sell to another a commodity for a specified price at a specified time. Because futures contracts are fixed, a party can be affected if the price moves in an adverse manner.
This is where futures options can help a trader. By purchasing a futures option the trader has obtained the right to buy or not to buy the contract. Another factor to consider is that a futures contract stands to lose a lot in case of market volatility. In contrast, the premium is the only amount a buyer will lose if he has an option.
Since its concept was introduced in 1982, it has become a constant feature in futures market trading.
In order to properly implement a futures option, the trader must become familiar with the terms and concepts associated with it.
If the forex trader wants to reserve the right to purchase a futures contract for a specified time period, he should purchase a call option. On the other hand, if he wants the right to sell that futures contract for a specific period, he needs the put option. As with everything in futures options, there is no obligation on the part of the buyer to undertake any of these actions.
The forex trader that buys a futures option is called the holder; the other party to whom it may be sold is the writer. If the holder sells the option to the writer, the amount exchanged is the premium.
The following are the financial and momentary terms used in options. The strike price, or exercise price, is the value of the futures contract for which it can be purchased or sold.
When an option is at-the-money, it means that the futures contract price is equivalent to the strike value. If the futures contract value is greater than the strike price, then the call option is termed in-the-money. Out-of-the-money signifies that the exercise price is greater than the futures contract. It should be noted that margin calls are not applicable to a holder, but if the seller does not buy and the option is carried out, he must pay a margin.
Futures options are there for the trader, and it is up to him to decide if he wants to use it. However, whether it is utilized or not, the important fact is that a forex trader knows that the resource is there should the need for it arise. Knowing the essential facts is, after all, the hallmark of a good forex trader.
