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The Basics of Options

 August 08, 2007 11:30 PM


 

An option on a futures contract is just like an option on anything else such as an individual stock. The only difference is that, with options on futures, the underlying interest is a futures contract. For instance, a May option on frozen concentrated orange juice (FCOJ) has as its underlying interest one May FCOJ futures contract.

Call and Put Options
A call option gives the holder the right, but not the obligation, to buy the underlying interest at a known price which is the strike price of the option at or prior to option expiration. To buy an option costs money and this cost is referred to as the option premium. The holder can effect the purchase of the underlying interest by exercising the option. For example, a June Deutschemark call option having a strike price of $0.6355 might cost $350. Anyone willing to pay $350 - the option premium - can acquire this option which will give the holder the right to buy one June Deutschemark futures contract at a price of $0.6355 on or prior to the option's expiration. For every option buyer, there is an option seller. The seller of a call option receives the option premium but, in return, must sell the underlying interest to the option holder if the holder exercises the option. As the price of the underlying interest rises, a call option increases in value. This accrues as a gain to the option buyer and a liability to the option seller.

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A put option gives the holder the right, but not the obligation, to sell the underlying interest at a known price which is the strike price of the option at or prior to option expiration. The option buyer pays the option premium. The holder can effect the sale of the underlying interest by exercising the option. For example, a June Deutschemark put option having a strike price of $0.6395 might cost $475. Anyone willing to pay $475 - the option premium - can acquire this option which will give the holder the right to sell one June Deutschemark futures contract at a price of $0.6395 on or prior to the option's expiration. For every option buyer, there is an option seller. The seller of a put option receives the option premium but, in return, must buy the underlying interest from the option holder if the holder exercises the option. As the price of the underlying interest falls, a put option increases in value. This accrues as a gain to the option buyer and a liability to the option seller.

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Quoting Option Prices
In the option trading pit and in newspapers, option prices are quoted in terms of ticks, or minimum price fluctuations, and not the full price in dollars and cents. To determine the actual dollar cost of an option, you need to multiply the market price in ticks by the dollar value of a tick. (The tick value of an option is almost always the same as the tick value of the futures.


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