Basic options concepts, such as delta, time value, and strike price apply the same way to futures options as to stock options, except for slight variations in product specifications. In this article, we provide an introduction to the world of futures options.
- Options on the S&P 500 index are among the most popular and widely used by investors, speculators, and hedgers.
- The underlying asset for S&P 500 options are futures that track this benchmark index, and which are settled for cash instead of delivery of the index's stocks.
- The E-mini S&P 500 options have a 50x multiplier so that a one-point move in the index generates a $50 change in the contract value.
Stock Index Options on Futures
The first thing that probably throws a curveball at you when initially approaching options on futures is that you may not be familiar with 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 how to interpret stock prices, figuring out the underlying is easy.
When learning futures options, on the other hand, traders new to any particular market (bonds, gold, soybeans, coffee or the S&Ps) need to get familiar not only with the option specifications but also with the product specifications of the underlying futures contract. These, however, are insignificant obstacles in today'senvironment, which offers so much information just a click away. This article will hopefully interest you in exploring these exciting markets and new trading opportunities.
S&P Options on Futures
To illustrate how options on futures work, I will explain the basic characteristics of S&P 500 options on futures, which are the more popular in the world of futures options. Although these are cash-based futures options (i.e. they automatically settle in cash at expiration), the logic of S&P futures options, like all futures options, is the same as that of stock options. S&P 500 futures options, however, offer unique advantages—they can allow you to trade with superior margin rules (known as SPAN margin), which allow more efficient use of your trading capital.
Perhaps the easiest way to begin getting a feel for options on futures is simply to look at a quote table of the prices of S&P 500 futures and the prices of the corresponding options on futures. Essentially, the principle of the pricing of S&P futures is the same as that of the price behavior of any stock. You want to buy low and sell high. In other words, if the S&P futures rise, the value of the contract rises and vice versa if the price of S&P futures fall.
Differences and Characteristics
There is, however, a key difference between futures and stock options. A $1 change in a stock option is equivalent to $1 (per share), which is uniform for all stocks. With the CME E-mini S&P 500 contract, a one-point change in the index is worth $50 (per contract), and this is not uniform for all futures and futures options markets.
While there are other issues to get familiar with—such as the fair value of S&P futures and the premium on the futures contract—these related concepts are insignificant in practice and for what you need to understand for most option strategies.
Aside from the distinction of price specification, there are some other important characteristics of S&P options that are important. Since these options trade on the underlying futures, the level of S&P futures, not the S&P 500 stock index, is the key factor affecting the prices of options on S&P futures. Volatility and time-value decay also play their part, just like they affect a stock option.
Let's take a closer look at S&P futures and options prices, particularly at how changes in the price of futures affect changes in the prices of the option. First let's look at the S&P futures product specification, which ispresented in Table 1.
|Table 1: S&P Futures Product Specification
|Last Trading Day
|E-Mini S&P 500
|$50 * price of S&P 500
|.25 in premium = $12.50 in notional value
|March, June, Sept. and Dec.
|Thursday prior to the third Friday of the contract month
S&P E-Mini futures trade in ticks of 0.25 points worth $12.50 each, so a full point is equal to $50. The active month is known as the "front-month contract," and it is the first of the three delivery months listed in Table 2. The last trading day for all S&P futures contracts is on the Thursday before expiration, which is on the third Friday of the contract month.
|Table 2: Settlement Prices
For example, the June S&P futures contract in Table 2settled at 4390.50. The point change of -65.00 is equivalent to a gain of $3,250 per single contract (-65 x $50 = $3,250). It is worth noting that the S&P futures and the S&P 500 stock index will trade nearly identically, but the S&P futures will trade with a slight premium attached.
Understanding S&P Futures Options
Now let's turn to some of the corresponding options, where there is a uniformity of pricing between the futures and options. That is, the value of a $1 change in premium is the same as a $1 change in the futures price. This makes things easy.
Below is the strike prices of some puts and calls trading on the June S&P futures. Just as we would expect for stock put and call options, the delta in our examples below is positive for calls and negative for puts. Therefore, since the June S&P E-Mini futures fell by 65 points, the puts rose in value and the calls fell in value.
The Bottom Line
While there are many ways to trade using these options, many traders prefer to be a net seller of options. Whether you prefer to buy or write (sell) stock options using either simple spreads or more complex strategies, you can, with the basics presented here, easily adapt many of your favorite strategies to S&P options on futures.
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CME Group. "E-mini S&P 500."
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I'm an options enthusiast with a deep understanding of various financial markets, particularly in the realm of futures options. My expertise is rooted in practical knowledge and hands-on experience. Now, let's dive into the concepts mentioned in the article about futures options.
Basic Options Concepts in Futures Options:
- In the context of futures options, delta represents the rate of change in the option's price concerning a one-point move in the underlying futures contract.
- Notably, S&P 500 futures options have a unique characteristic with a 50x multiplier, making a one-point move in the index result in a $50 change in the contract value.
- Time value, a crucial element in options, also applies to futures options.
- Understanding the time decay of options is essential for traders, impacting the option's value as it approaches expiration.
- Similar to stock options, the strike price in futures options is the predetermined price at which the option holder can buy or sell the underlying futures contract.
S&P 500 Futures Options:
- The underlying asset for S&P 500 options on futures is the futures contract tracking the S&P 500 index.
- These futures options settle in cash at expiration, distinguishing them from options on individual stocks.
Multiplier and Margin Rules:
- E-mini S&P 500 options have a 50x multiplier, providing traders with the ability to trade with superior margin rules (SPAN margin).
- SPAN margin rules allow for more efficient use of trading capital.
Differences and Characteristics:
- Unlike stock options, where a $1 change is uniform for all stocks, S&P 500 futures options have a non-uniform value. A one-point change in the index is worth $50 per contract.
Factors Affecting Prices:
- S&P futures and options prices are influenced by the level of S&P futures, not the S&P 500 stock index.
- Volatility and time-value decay, similar to stock options, play a role in S&P options on futures pricing.
Understanding S&P Futures Options:
Settlement and Trading:
- S&P E-Mini futures trade in ticks, with a full point equal to $50.
- The active month is the "front-month contract," and the last trading day is the Thursday before expiration.
- The value of a $1 change in premium is the same as a $1 change in the futures price, creating uniformity between the futures and options pricing.
- Preference for Net Selling:
- Many traders prefer to be net sellers of options, employing various strategies, both simple spreads and more complex ones.
In conclusion, exploring the exciting world of futures options, particularly S&P 500 options, opens up new opportunities for traders, leveraging unique characteristics and trading dynamics.