main reason to buy an option on a futures contrat?

Question

rather than the futures conract

Answer 1

Knihelpu is almost right. Options on futures control the same amount of the futures, not 100 per options contract (he's thinking equity options). His example of oil; a futures contract is 1000 bbl per contract, so is the options, but the premium is less than the margin on the futures. For example, the initial margin on crude futures is $4050 and $3000 maintenance, but the premium on a Feb. 07 63.00 call (with the Feb '07 futures settling at 62.07) is $1.85. At 1000 per contract, the premium is $1850.

But the poster is correct in the fact that if you buy options, your risk is limited to the premium (if you write options the risk is unlimited, but has a greater chance of being profitable - that's another topic), but with a futures contract your risk is unlimited.

For example, take the Feb '07 futures and the Feb '07 63 Call. Say you bought both at the above prices. Let's say oil tanked and dropped to $45 per barrel. The option would probably expire worthless, so the most you'd lose is the $1850 premium, but with futures, that move to $45 would be a $17.07 loss ($62.07 close price as of today minus the $45 hypothetical loss price). At 1000 barrel per contract, that's a $17,070 loss.

Hope this answers your question

Answer 2

An option contract on a future works the same way as it does for a stock. You are purchasing the right to by a commodity for a given price as a given date.

Say, a futures contract on Feb 07 oil is going for $70 a barrel. If you purchase the future you need to put up at least 10% of the amount of the future, and you are responsible for the remaining balance on the due date, unless you sell it before hand.

With an option, you might pay, say $1 per option for the right to buy the oil at $70/bbl. Options typically trade at 100 per contract, so you would need to pay $100 to control the rights to futures contracts.

The advantage of the option is that you have limited your down side, to just the $100. You have no further obligation. With the future, if oil tanks, so to speak, you either need to put up more cash, or liquidate your holdings at a loss.

The price of the option will move with the price of the future, just not as much. This limits your upside dollar potential, but increased your percentage gain.

Say oil moves up to 75, you would profit 5 dollars, but just a small percentage or you overall investment. With the option, if oil moves to 75, the option should rise to about 4, your profit would only be 3 dollars, but a 300% return on your 1 dollar investment.

Answer 3

This is actually a double hedge. If you have underlying asset which has to be hedged with futures and you don't want to go wrong in the derivative market. Also, to make profit in the direction you believe the mrket might move but not 100% sure.

Answer 4

The option costs less money, increasing the profit, and lowering the loss potential.