Futures contracts are available for all sorts of financial products, from equity indexes to precious metals. Trading options based on futures means buying or writing call or put options depending on the direction you believe an underlying product will move. (For more on how to decide which call or put option to use, see "Which Vertical Option Spread Should You Use?")

Buying options provides a way to profit from the movement of futures contracts, but at a fraction of the cost of buying the actual future. Buy a call if you expect the value of a future to increase. Buy a put if you expect the value of a future to fall. The cost of buying the option is the premium. Traders also write options.

Options on Futures

Many futures contracts have options attached to the them. Gold options, for example, are based on the price of gold futures (called the underlying), both cleared through the Chicago Mercantile Exchange (CME) Group. Buying the future requires putting up an initial margin of $7,150--this amount is set by the CME, and varies by futures contract--which gives control of 100 ounces of gold. Buying a $2 gold option, for example, only costs $2 x 100 ounces = $200, called the premium (plus commissions). The premium and what the option controls varies by the option, but an option position almost always costs less than an equivalent futures position. (For insight on how gold prices are set, see "The Insiders Who Fix Rates for Gold, Currencies, and Libor")

Buy a call option if you believe the price of the underlying will increase. If the underlying increases in price before the option expires, the value of your option will rise. If the value doesn't increase, you lose the premium paid for the option.

Buy a put option if you believe of the underlying will decrease. If the underlying drops in value before your options expires, your option will increase in value. If the underlying doesn't drop, you lose the premium paid for the option.

Option prices are also based on 'Greeks,' variables which affect the price of the option. Greeks are a set of risk measures that indicate how exposed an option is to time-value decay.

Options are bought and sold before expiration to lock in a profit or reduce a loss to less than the premium paid.

Writing Options for Income

When someone buys an option, someone else had to write that option. The writer of the option, who can be anyone, receives the premium from the buyer up front (income) but is then liable to cover the gains attained by the buyer of that option. The option writer's profit is limited to the premium received, but liability is large since the buyer of the option is expecting the option to increase in value. Therefore, option writers typically own the underlying futures contracts they write options on. This hedges the potential loss of writing the option, and the writer pockets the premium. This process is called "covered call writing" and is a way for a trader to generate trading income using options, on futures she already has in her portfolio.

A written option can be closed out at any time, to lock in a portion of the premium or limit a loss.

Trading Options Requirements

To trade options you need a margin approved brokerage account with access to options and futures trading. Options on futures quotes are available from the CME (CME) and the Chicago Board Options Exchange (CBOE), where options and futures trade. You can also find quotes in the trading platform provided by options brokers.

The Bottom Line

Buying options on futures may have certain advantages over buying regular futures. The option writer receives the premium upfront but is liable for the buyers gains; because of this, option writers usually own the own the underlying futures contract to hedge this risk. To buy or write options requires a margin approved brokerage account with access to CME and/or CBOE products.

Related Articles
  1. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  2. Investing

    Oil: Why Not to Put Faith in Forecasts

    West Texas Intermediate oil futures have recently made pronounced movements. What do they bode for the world market?
  3. Options & Futures

    Pick 401(k) Assets Like A Pro

    Professionals choose the options available to you in your plan, making your decisions easier.
  4. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  5. Economics

    Is the U.S. Economy Ready for Liftoff?

    The Fed continues to delay normalizing rates, citing inflation concerns and “global economic and financial developments” in explaining its rationale.
  6. Mutual Funds & ETFs

    The Risks of Investing in Inverse ETFs

    Discover analyses of the risks inherent to inverse exchange-traded funds (ETFs) that investors must understand before considering an investment in this type of ETF.
  7. Mutual Funds & ETFs

    Top 4 Inverse Equities ETFs

    Explore analysis of some of the most popular inverse and leveraged-inverse ETFs that track equity indexes, and learn about the suitability of these ETFs.
  8. Investing

    The Best Strategies to Manage Your Stock Options

    We look at strategies to help manage taxes and the exercise of incentive and non-qualified stock options.
  9. Investing Basics

    Retirement Planning Using Long-Dated Options

    Retirement planning using high-risk options? It is possible, and studies confirm better yields than conventional methods. Here’s how.
  10. Investing Basics

    Understanding Vega

    In options trading, vega represents the amount option prices are expected to change in response to a change in the underlying asset’s implied volatility.
  1. How much does China's growth affect the price of industrial metals?

    Chinese buyers demand more industrial metals than the rest of the world combined. When China experiences strong growth and ... Read Full Answer >>
  2. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  3. How do futures contracts roll over?

    Traders roll over futures contracts to switch from the front month contract that is close to expiration to another contract ... Read Full Answer >>
  4. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  5. Why do companies enter into futures contracts?

    Different types of companies may enter into futures contracts for different purposes. The most common reason is to hedge ... Read Full Answer >>
  6. What does a futures contract cost?

    The value of a futures contract is derived from the cash value of the underlying asset. While a futures contract may have ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  2. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  3. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  4. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  5. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  6. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!