What Is a Serial Option?
A serial option is a short-term option written on a futures contract that can be bought, but prior to when the underlying contract has not yet been listed. Doing so can give them "first dibs" on the contract, at a locked-in price, when it does next become available—generally, in the following month.
- A serial option is essentially a call option that gives the holder the right to buy a futures contract that will soon be listed.
- Serial option are intended to provide hedging strategies when a futures contract is currently unavailable.
- Since the time to expiration of a serial option is shorter than for many conventional listed options, the option's premium is lower as well.
Understanding Serial Options
If an investor wants to purchase a futures contract that's not yet available, they can buy a serial option for it. If they exercise the serial option when the futures contract is listed for sale, then they will own that contract.
Standard option contracts are traded for months in which futures contracts expire. Serial options are listed for months where there is not an expiry of the underlying futures contract. A serial option expires before the underlying security comes to maturity. Exercising the option assigns the holder with a position of the nearby month futures contract. Usually, the underlying futures contract will expire in the following month.
Most serial options are written for the next month following their purchase, and so a serial option trades only for only about 30 days or less. They typically begin trading five days before the expiration of a standard option contract or the current serial option contract.
How a Serial Option Works
Here's how it works: Say corn futures contracts (and standard options on those contracts) trade in July and September, but not August. The July standard corn option contract expires Friday, June 19. So trading on the August serial option contract—the right to buy a September corn futures contract—would open on Monday, June 15. Its price would be based on the September futures contract price.
Exchanges created the serial option to provide commodity investors a chance to buy, and producers a short-term way to protect the price of their product when a futures contract is unavailable. Essentially, it is a tool that lets hedgers manage short-term risk at a low cost. Since the time to expiration of a serial option is shorter than that of many conventional listed options, the serial option's premium is lower as well. Traders can also use a serial option to extend a hedge from one month to the next by rolling it forward.
Example of a Serial Option
For example, assume that a gold futures contract trades for February, April, June, August, October, and December. So, there is no listed gold futures contract for January, March, May, July, September, and November. A trader, seeking to hedge their exposure to gold for March, might be interested in purchasing a March serial option since there is an April futures contract available. This would give the trader the right to exercise the March serial option upon its expiration, which will put the trader in a position for the April futures contract.
It does not really matter what the underlying asset represents, so long as the price involved is represented by a futures contract and does not reflect the spot market.
Serial options became popular around the turn of the 21st century. The Chicago Board of Trade (CBOT), one of the leading commodities exchanges in the U.S., introduced them to its members in 1998.
Over the past few years, as futures contracts—particularly for commodities—have become listed on electronic exchanges, gaps in contract months have largely disappeared. At the same time, options listed on a weekly or even daily basis have arisen in several markets. In such cases, the weekly or other shorter-term options have replaced the serial options that expired in off months.