Future Option - Believing The Future Holds An Option For Profit

A future option is actually a contractual right that indicates a belief there is

a possibility of making money in the future on stocks, commodities or other underlying assets. There are two terms to understand right up front though.

- Futures contract: legally binding contract to buy or sell a named commodity at a specific price at a specific location and at a specific date

- Options on futures contract: a right, not an obligation, to buy or sell a futures contract at a specific price by a specific date

Options investors are buying futures contracts or stock options if trading in stocks rather than commodities. Stocks and futures contracts are two very different markets though the vocabulary and principles are the same. A future option indicates an investor has a chance to invest in a financial vehicle to gain an opportunity to make a profit.

Trading options is fairly complex but can be mastered by anyone serious about learning the options markets. The first thing to do is learn the basic terminology like calls, puts, strike price, holder (buyer), writer (seller) and premium. The premium is what the buyer pays a person selling an option and is one of the main determinants of whether you manage your loss or realize a profit.

Premium

A premium is paid at the time the option is purchased. It is equal to the intrinsic value of the option plus the time value. Therefore, these two future option features most influence the premium of course.

The intrinsic value represents the amount of money that could be realized if the option was to be exercised at the strike price. At the time the option is realized, the futures position is liquidated. The value of the liquidation depends on the current market price of the futures contract. A future option has intrinsic value when it is in the money.

Time value equals the amount of money someone is willing to pay now to obtain the option rights that can be exercised in the future. Time value represents an amount that is over the intrinsic value. Time is measured in three ways.

- How long it will take the market price and an option price to reduce an out of the money condition because the further apart the strike price and market price are the less time value the option will have

- How much time remains until the option expires because the time value erodes as the expiration date gets closer

- How volatile the market is because volatility can lead to beneficial price changes

Reading the factors determining premiums on future option trades makes it clear that learning the terms and pricing concepts is important to trading success.

Quotations

Where can you find quotations for options? You can find them in financial newspapers like the Wall Street Journal or online. The quotations will include commodity specific information like the strike price, the calls and puts by expiration month, and the transaction volume.

It is possible to purchase software today that will provide daily quotes and identify possible trading opportunities. But even with software, the future option trader must have an excellent understanding of how to interpret the information. Options trading should only be undertaken after spending the time and effort it takes to learn how to successfully maneuver the market.

by: EeLynn Lee

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