20 August 2009

Futures Options - Part 2

This is Part 2 of our look at futures options.

Contract Size.

Whereas a stock option is a right to buy or sell a parcel of a certain number of shares, a futures option is the right to buy or sell a futures contract. This is quite easy then, one option = one future. As a futures contract it is the right to buy or sell another derivative contract, this explains some of the various nuances of futures option.

Expiry

Stock options all typically expire on the same day in the monthly cycle. In the US, this is the third Friday of the month and all stock options are on a certain expiry cycle as per THIS LINK. It's all pretty easy to work out once you know how it works.

Futures options are different. While the US stock index options expire on the same day as stock options, commodity futures options all have there own expiration nuances that can take some time to get used to. Many commodity options actually expire the month before the contract month. For example, The December 2009 cocoa future expires on the 15th Dec, but the December 2009 cocoa option expires on the 6th November. The reason for this in this particular contract is that the option expires before the first notice day, where holders of futures contracts are required to notify their intentions for delivery of the physical commodity (Speculative traders will have exited this contract before then).

Every futures option is different and the exchanges website should be consulted as to the exact expiry of the option concerned. For a handy 2009 expiration guide for futures and their options, have a look here at Daniels Trading have put together.

Exercise

This is another nuance which is different for each commodity.

A stock option relates to the physical delivery of a parcel of shares. When you exercise or are assigned, you deliver or accept delivery of the number of shares in question.

As stated above, a futures option is an option on a futures contract. That is where the certainty ends.

Firstly there are regular expiry contracts and then there are serial expiry contracts. A regular exiry is an option whose expiry correlates to the futures expiry (even if it expires the month before). An example is the cocoa option mentioned above; the December option correlates to the December future, both are Z expiry.

However, futures options may have expiries between futures contract months. For example, if you look at our cocoa options example, there are options which are V (October) and X (November) expiry that do not have their own futures expiry. These are called serial expiry options. These are options on the Z (December) contract.

Confused?

It doesn't stop there. In some commodity options, the regular and serial expiry options may be settled in different ways. In some cash settled futures, the regular expiry options are settled in cash, whereas the serial options are settled with the futures contract.

The key is to always refer to the exchanges website to make sure of the expiry date and the settlement terms.

Enough for now, stay tuned for part 3

2 comments:

patricewilliam said...

Very thoughtfull post on futures options. It should be very much helpfull.

Thanks,
Karim - Positive thinking

karim said...

Very thoughtfull post on mind .It should be very much helpfull.

Thanks,
Karim - Creating Power