Basic options concepts, resembling delta, time value, and strike price apply the identical method to futures options as to stock options, apart from slight variations in product specifications. In this text, we offer an introduction to the world of S&P 500 futures options.

Stock Index Options on Futures

The very first thing that probably throws a curveball at you when initially approaching options on futures is that it’s possible you’ll not be aware of a futures contract—the underlying instrument upon which options on futures trade. Recall that for stock options, the underlying is the equity issue (e.g. IBM call options trade on IBM stock). Since most investors understand the best way to interpret stock prices, determining the underlying is simple.

When learning futures options, then again, traders recent to any particular market (bonds, gold, soybeans, coffee or the S&Ps) must get familiar not only with the choice specifications but in addition with the product specifications of the underlying futures contract. These, nonetheless, are insignificant obstacles in today’s environment, which offers a lot information only a click away. This text will hopefully interest you in exploring these exciting markets and recent trading opportunities.

S&P Options on Futures

For example how options on futures work, I’ll explain the fundamental characteristics of S&P 500 options on futures, that are the more popular on this planet of futures options. Although these are cash-based futures options (i.e. they mechanically settle in money at expiration), the logic of S&P futures options, like all futures options, is identical as that of stock options. S&P 500 futures options, nonetheless, offer unique benefits—they’ll permit you to trade with superior margin rules (generally known as SPAN margin), which permit more efficient use of your trading capital.

Perhaps the simplest method to begin getting a feel for options on futures is solely to have a look at a quote table of the costs of S&P 500 futures and the costs of the corresponding options on futures. Essentially, the principle of the pricing of S&P futures is identical as that of the value behavior of any stock. You should buy low and sell high. In other words, if the S&P futures rise, the worth of the contract rises and vice versa if the value of S&P futures fall.

Differences and Characteristics

There’s, nonetheless, a key difference between futures and stock options. A $1 change in a stock option is reminiscent of $1 (per share), which is uniform for all stocks. With the CME E-mini S&P 500 contract, a one-point change within the index is price $50 (per contract), and this just isn’t uniform for all futures and futures options markets.

While there are other issues to get aware of—resembling the fair value of S&P futures and the premium on the futures contract—these related concepts are insignificant in practice and for what it’s essential to understand for many option strategies.

Apart from the excellence of price specification, there are another essential characteristics of S&P options which are essential. Since these options trade on the underlying futures, the extent of S&P futures, not the S&P 500 stock index, is the important thing factor affecting the costs of options on S&P futures. Volatility and time-value decay also play their part, identical to they affect a stock option.

Let’s take a more in-depth have a look at S&P futures and options prices, particularly at how changes in the value of futures affect changes in the costs of the choice. First let us take a look at the S&P futures product specification, which is presented in Table 1.