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Options on futures are relatively easy to understand once you master the basic vocabulary. Only advanced options concepts and strategies require complex mathematics.OptionAn option on a futures contract is the right, but not the obligation, to buy or sell a particular futures contract at a specific price on or before a certain expiration date. There are two types of options: call options and put options. Each offers an opportunity to take advantage of futures price moves without actually having a futures position.Call OptionA call option gives the holder (buyer) the right to buy (go long) a futures contract at a specific price on or before an expiration date. For example, a September CME® Japanese Yen 85 call option gives the holder (buyer) the right to buy or go long a yen futures contract at a price of 85 (shorthand for $.0085/yen) anytime between purchase and September expiration. Even if yen futures rise substantially above .0085, the call holder will still have the right to buy yen futures at .0085.Put OptionA holder of a put option has the right to sell (go short) a futures contract at a specific price on or before the expiration date. For example, an October 70 CME Live Cattle put gives the put holder the right to sell October CME Live Cattle futures at 70 cents/lb. Should the futures decline to 64 cents/lb., the put holder still retains the right to go short the contract at 70 cents/lb.Option BuyerAn option buyer can choose to exercise his or her right and take a position in the underlying futures. A call buyer can exercise the right to buy the underlying futures and a put buyer can exercise the right to sell the underlying futures contract. In most cases though, option buyers do not exercise their options, but instead offset them in the market before expiration, if the options have any value.Option SellerAn option seller (i.e., someone who sells an option that he or she didn't previously own) is also called an option writer or grantor. An option seller is contractually obligated to take the opposite futures position if the buyer exercises his or her right to the futures position specified in the option the buyer has purchased. In return for the premium, the seller assumes the risk of taking a possibly adverse futures position.Puts and CallsPuts and calls are separate option contracts; they are not the opposite side of the same transaction. For every put buyer there is a put seller, and for every call buyer there is a call seller.The option buyer pays a premium to the seller in every transaction. The following is a list of the rights and obligations associated with trading put and call options on futures.Exercise PriceAlso known as the strike price, the exercise price is the price at which the option buyer may buy or sell the underlying futures contracts. Exercising the option results in a futures position at the designated strike price. For example, by exercising a September CME E-miniTM S&P 500® 1200 call, the buyer of the option would then be long a September CME S&P 500 contract at 1200. If the holder of a June CME Live Cattle 80 put were to exercise his or her option, the result would be a short futures position, at 80, in June CME Live Cattle.Strike prices are set by the Exchange and have different intervals depending on the underlying contract. Strike prices are set above and below the existing futures price and additional strikes are added if the futures move significantly up or down.Underlying Futures ContractThe underlying is the corresponding futures contract that is purchased or sold upon the exercise of the option. For example, an option on a June CME Live Cattle futures contract is the right to buy or sell one such contract. An option on September CME Canadian dollar futures gives the right to buy or sell one September CME Canadian dollar futures contract.
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