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.
Key Takeaways
- 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 | ||||
|---|---|---|---|---|
| Futures Contract | Contract Value | Tick Size | Delivery Months | 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 | ||||
|---|---|---|---|---|
| Contract | High | Low | Settlement | Point Change |
| June 2022 | 4385.75 | 4380.00 | 4390.50 | -65.00 |
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.
:max_bytes(150000):strip_icc()/eminioptions-c8a2a64cc63f47fcab749baead93b8c0.jpeg "An Introduction To Options On S&P 500 Futures (1)")
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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As an experienced trader and enthusiast in the field of futures and options trading, I've spent years delving into the intricacies of various financial instruments and market dynamics. My expertise extends across a spectrum of trading strategies, from basic concepts like delta and time value to more nuanced aspects such as volatility analysis and options pricing models.
In the realm of options trading, understanding the fundamental concepts is paramount. Delta, for instance, represents the rate of change of the option's price with respect to changes in the underlying asset's price. It essentially quantifies the sensitivity of the option's value to movements in the underlying. Time value, on the other hand, refers to the portion of an option's premium that is attributable to the time remaining until expiration, reflecting the potential for further price movements. Strike price dictates the price at which the underlying asset can be bought or sold when exercising the option.
Now, let's dissect the concepts mentioned in the article you provided:
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S&P 500 Index Options: These options are among the most popular in the world, providing investors with exposure to the performance of the S&P 500 index. They are widely utilized by investors, speculators, and hedgers alike.
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Underlying Asset: The underlying asset for S&P 500 options is futures contracts that track the S&P 500 index. Unlike stock options, these futures options are settled for cash rather than physical delivery of the index's stocks.
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Multiplier: E-mini S&P 500 options have a multiplier of 50x, meaning that a one-point move in the index translates to a $50 change in the contract value. This multiplier plays a crucial role in determining the contract's value and potential profits or losses.
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Product Specifications: Understanding the product specifications of the underlying futures contract is essential when trading options on futures. Traders need to familiarize themselves with contract values, tick sizes, delivery months, and last trading days, among other details.
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Pricing Dynamics: The pricing of S&P futures and options is influenced by factors such as market volatility, time decay, and changes in the underlying futures price. Traders aim to buy low and sell high, just like with stocks, but with the added complexity of futures pricing dynamics.
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Options Pricing: Options on S&P futures exhibit pricing characteristics similar to stock options, with changes in the underlying futures price directly impacting the options' prices. The relationship between the two is crucial for devising trading strategies and managing risk effectively.
By understanding these fundamental concepts and their application in the context of futures options trading, investors can navigate the complexities of the market with confidence and precision. Whether you're a seasoned trader or just starting, grasping these concepts lays a solid foundation for success in the world of options on futures.
