Buying Options on Futures Contracts

by National Futures Association (NFA)

Introduction

Although futures contracts have been traded on U.S. exchanges since 1865, options on futures contracts were not introduced until 1982. Initially offered as part of a government pilot program, their success eventually led to widespread use of options on agricultural as well as financial futures contracts. Options on futures contracts can offer a wide and diverse range of potentially attractive investment opportunities. However, options trading is a speculative investment and should be treated as such. Even though the purchase of options on futures contracts involves a limited risk (losses are limited to the costs of purchasing the option), it is nonetheless possible to lose your entire investment in a short period of time. And for investors who sell rather than buy options,there is no limit at all to the size of potential losses.This information is designed to provide you with a basic understanding of options on futures contracts—what they are, how they work and the opportunities (and risks) involved in trading them. This feature consists of four parts:

Part One: The Vocabulary of Options Trading. Options investing has its own language—words or terms you may be unfamiliar with or that have a special meaning when used in connection with options.

Part Two: The Arithmetic of Option Premiums. This section describes the major factors that influence option price movementsand the all-important relationship between option prices and futures prices.

Part Three: The Mechanics of Buying and Writing Options. This section outlines the basic steps involved in buying and writing options, as well as the risks involved.

Part Four: A Pre-Investment Checklist. This section lists additional steps you should take before deciding whether to trade options on futures.