How an Option on Futures Can Lead to a Big Return on Investment

An option on a futures contract gives the buyer the right, but not the obligation, to buy or sell a futures contract at a strike price on or before an expiration date.

Using an option on a futures contract is another tool investors can use to diversify and expand their investment portfolio. By reading this article, investors will gain a basic understanding of how an option on a futures contract works.

An option on a futures contract is very similar to a stock option. The key difference between the two options is that a futures option when exercised assumes a futures position.

The holder of a call option would enter into the long side of a futures contract and buy the underlying asset at the strike price. The writer of a call option would enter into the short side of a futures contract and sell the underlying asset at the strike price.

The holder of a put option would enter into the short side of a futures contract and sell the underlying asset at the strike price. The writer of a put option would enter into the long side of a futures contract and buy the underlying asset at the strike price.

Futures options usually expire at the end of the month that precedes the delivery month of the underlying futures contract. For example, a May option would expire in April.

A futures option derives its value from the futures contract, not the underlying asset of the futures contract. When the futures price moves, the futures option price will move.

An option on a futures contract is another strategy investors can use to generate a profit or hedge against a loss. After reading this article, investors should have a basic understanding of how options on futures contracts work.