What Are Futures Options And How Do They Work?

In simple terms, a futures option is an investment that gives the option buyer the right – but not the obligation – to buy or sell a particular futures contract at a stated price at any point prior to the specified contract expiration date. An option can be of two kinds, a call option (to buy) or a put option (to sell).

The price at which the buyer of a call has the right to purchase a specific futures contract, or at which the buyer of a put has the right to sell a specific futures contract, is generally known as the strike price.

However, unlike other financial instruments, options on futures contracts are not purchased at their full value. What is traded by buyer and seller for a futures option is a premium. The value of a premium is determined by open competition between buyers and sellers according to the rules of the exchange where the options are traded.

An option that has been previously purchased or sold can usually be liquidated, or offset, prior to the contract's expiration by making a trade. In general, most options investors will opt to realise profits or limit their losses by an offsetting sale or purchase.