Options on Futures
Options on futures are typically a contract to buy or sell non-traditional
commodities, such as foreign currencies, commercial or government bonds,
baskets of corporate equity, or other financial instruments. These are
typically traded on a futures exchange.
Futures are exchange-traded and are not dealt over the counter, which
requires only an agreement between two parties. Futures are margined and have
significantly less credit risk than credit forwards.
The future date is called the delivery date or the final settlement date.
The settlement price is the official price of the futures contract at the
end of a day's trading session. The deliverables have a grade, which
specifies the quality of the product and the location of the delivery. For
example, a contract for sweet crude oil specifies the maximum rate of sulphur
and the product's specific gravity.
Settlement of the option on futures can be done with physical delivery of the
product (a process that is uncommon) or with a cash settlement.
An option of futures gives the buyer the right, but not the obligation, to
establish a position previously held by the seller of the option. The owner
may exercise the contract if they choose, but both parties of the futures
contract must fulfill the contract by the settlement or expiration date.
Futures contracts are exchange traded derivatives. The exchange's
clearinghouse acts as a counterparty, sets margin requirements and acts as a
mechanism for settlement.
Futures contracts began in Ancient Greece and can be found in the writings of
Aristotle, who wrote about a philosopher who negotiated options with local
oil-press owners and made a fortune when the crops came in and there weren't
enough presses available. The first futures exchange market was founded in
Japan in the 1700s by a Samurai who sought a way to convert rice payments he
received into cash.
Types of Exchange Traded Options
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