Derivatives

CHAPTER 20Options on Futures

Aims

• To analyse futures options, that is, options contracts where the underlying asset is a futures contract.
• To explain price quotes, delivery and settlement procedures.
• To establish upper and lower bounds for the price of European calls and puts on futures.
• To examine payoffs and trading strategies using futures options.
• To examine the relative merits of options on spot assets and options on futures contracts.

A futures option is an option where the underlying asset to be delivered is a futures contract. The futures contract itself could, for example, be written on T-bonds, Eurodollar interest rates, spot-FX rates or commodities such as corn or oil. Most futures options are American style options. The main advantage they have over options on the spot asset is that they deliver a futures contract, which is highly liquid and easy to close out at low cost. The latter can sometimes make them more attractive than using options on the underlying spot asset itself.

20.1 MARKET CONVENTIONS

A long American call (put) option on a futures contract gives the holder the right, but not the obligation, to buy (or sell) a futures contract at the strike price, up to and including the maturity date of the option.

Some of the most popular futures options are on T-bond and T-note futures (CBOT), on Eurodollar futures (CME), on EURIBOR futures (Euronext-LIFFE) and on the S&P 500 futures contract. Other futures options which are also actively traded, include those ...