Futures Strategies: Using Put and Call Options

Because of the volatility and uncertainty in the forex and futures market today, it is imperative to incorporate futures risk management strategies in your investment plans. One of the most preferred choices right now are futures options.

Options in futures contracts can be complex, but the fundamentals, such as put and call options, can be explained quite simply. It should be emphasized that the call and put options are separate and purchasing one does not entail buying the other.

If a futures or forex trader buys a call option, he earns the right to go long (buy) a futures contract for a specified price at any point during the duration of the option. A put option, on the other hand, allows a trader to go short on a contract at a specific price, also for the length of the option.

These two options can be used in your futures risk management strategies, as outlined below.

Suppose that in April, market analysis indicates that an oil price hike is inevitable. You buy a crude oil futures contract worth $5,000 (100 barrels at $50 per barrel). You purchase a call option for a $1,000 premium. If the price of oil goes up to $75 you will earn a profit of $1,500, minus the $1,000 you paid for the call option.

Of course, you could have earned the full $2,500 profit if you did not purchase the call option, but if the forex analysts were wrong, and the price falls to $30, you would incur a loss of over $2,500. However, with the option, your loss is limited to only a thousand dollars.

Put options are ideal when you intend to go short on futures contracts. Assuming that it is March and the price of wheat is $15 per bushel, you anticipate a decline by June. If you buy a put option worth $12 in June, then you can sell your contract at that price, regardless if wheat falls to under $10 by the end of May.

Of course, your profits have to be subtracted from the premium, but as in the call option example, it can mitigate your losses.

If you are going to include call and put options in your futures risk management strategy, then you should know how options premiums are priced. There are several factors that determine the price and value of a premium, and should be looked into. These include the exercise price (the amount at which it is bought), the value of the underlying instrument and of course, competition from option writers (those who sell futures options).

Generally speaking, a premium is more valuable if it is "in-the-money" than "out- of-the-money". When a futures option is said to be in-the-money, it means that the premium is higher than the strike price of a futures contract.

The opposite is true of an option that is out-of-the-money (i.e., an oil contract is worth $60. An in-the-money option will allow you to sell it for $65, while at out of the money option sells for only $55).

While options can limit your profits a bit, they are in general a good futures risk management strategy. While they may not be always applicable, a good forex trader always takes them into consideration.