week 8 Flashcards
What are Futures Options
- A futures option is the right, but not the obligation, to enter into a futures contract at a certain futures price by a certain date.
- The underlying security of a futures option is a futures contract, not a physical commodity. Exercising these options gives the holder a position in a futures contract.
- Most futures options are American, and thus can be exercised at any time during the life of the contract.
•A call futures option:
–is the right to enter into a long futures contract at a certain price; and,
–when the holder exercises the option they receive a cash amount equal to the excess of the futures price over the strike price.
A put futures option
–is the right to enter into a short futures contract at a certain price; and,
–when the holder exercises the option they receive a cash amount equal to the excess of the strike price over the futures price.
•Quotation of futures options:
–They are quoted by the month in which the underlying futures contract matures, not by the expiration month of the option.
–Most futures option contracts mature a few days before the underlying futures contract matures.
Why are Futures Options Popular
reason 1 and 2
- Futures contracts are generally more liquid than the underlying asset.
- Exercising a futures option does not usually lead to delivery of the underlying asset.
–The underlying futures contract is closed prior to delivery.
Therefore, futures options are normally settled in cash
Futures options also tend to entail lower transaction costs than spot options
Why are Futures Options Popular?
reason 3
•Futures on commodities are easier to trade than the commodities themselves.
–It is far easier and more convenient to make or take delivery of a pork-belly futures contract than it is to make or take delivery of the actual pork-bellies themselves.
If the European call futures option matures at the same time as the futures contract
what if If the European call futures option matures before the futures contract,
Ft=St
and the two options are equivalent.
European call futures option matures before the futures contract, it is worth more than the corresponding spot option in a normal market, and less in an inverted market.
A European futures put option is worth the same as its spot option counterpart when
•the futures option matures at the same time as the futures contract.
If the European put futures option matures before the futures contract, it is
•If the European put futures option matures before the futures contract, it is worth less than the corresponding spot option in a normal market, and more in an inverted market.
–American options are thus worth more than their European counterparts.
why
A holder of an American futures option may exercise their option earlier than a holder of a corresponding European option
American futures options may not be worth
–the same as the corresponding American options on an underlying asset.
•With some commodity markets such as gold and silver, the futures price is consistently higher than the spot price prior to maturity.
If an American call futures option is exercised early, then
–it will provide a greater profit to the holder.
If an American put futures option is exercised early,
it will provide a lower profit to the holder
, American call future options are generally worth more than
their American spot call option counterparts.
American put future options are generally worth less than their
why
. American put future options are generally worth less than their American spot put option counterparts.
–If an American put futures option is exercised early, then it will provide a lower profit to the holder.
