Big FOMC this week! Meeting takes place tomorrow and Thursday with much anticipated announcement and language on Thursday, 2 PM EST.

Futures Options 101:

Market Strategies

1. Bullish Market Strategies

2. Bearish Market Strategies

3. Neutral Market Strategies

Futures Options Writing

1. Most futures options expire worthless and out of the money. Therefore, the option writer is collecting the premium the option buyer paid.
2. There are three ways to win as an option writer. A market can go in the direction you thought, it can trade sideways and in a channel, or it can even go slowly against you but not through your strike price. The advantage is time decay.
3. The writer believes the futures contract will not reach a certain strike price by the expiration date of the option. This is known as naked option selling.
4. To hedge against a futures position. For example: someone who goes long cocoa at 850 can write a 900 strike price call option with about one month of time until option expiration. This allows you to collect the premium of the call option if cocoa settles below 900, based on option expiration. It also allows you to make a profit on the actual futures contract between 851 and 900. This strategy also lowers your margin on the trade and should cocoa continue lower to 800, you at least collect some premium on the option you wrote. Risk lies if cocoa continues to decline because you only collect a certain amount of premium and the futures contract has unlimited risk the lower it goes.

Option Buying & Spreads

Most futures options expire worthless and out of the money, therefore most people lose when buying options on futures. Cannon Trading believes there is still opportunity in buying , but you must be very patient and selective. We believe buying futures options just because a market is extremely high or low, known as “fishing for options” is a big mistake. Refer to the guidelines on our “Trading Commandments” before purchasing any futures options. Historic volatility, technical analysis, the trend and all other significant factors should all be analyzed to increase your probability of profit. All full-service accounts will receive these studies, opinions and recommendations upon request. Cannon Trading Company’s “Trading Commandments” can be used as a guideline to assist you in the process and decision making of selecting the right market and futures options to purchase.

1. If coffee is trading at 84, we can buy 1 coffee 100 call and write 2 135 calls with the same expiration dates and 30 days of time until expiration. This would be in anticipation of coffee trending higher, but not above 135 in 30 days. We’d be collecting the same amount of premium as we’re buying, so even if coffee continued lower we’d lose nothing. Our highest profit would be attained at 135 based on options on futures expiration. To determine risk we’d take the difference between 135 and 100, which is 35 points and divide it by two, because we sold two calls for every one purchased. You’d then add the 17.5 points to 135 and this would give you the approximate break-even point based on option expiration. Risk lies if coffee rises dramatically or settles over 152.50, based on expiration.
2. A typical calendar spread strategy we use often would be to write 1 option with about 25 days left until expiration and buy 1 with 60 days left. Example: If coffee was trading at 84 and we thought prices might be heading slowly higher. We can write 1 130 coffee call with less time and buy 1 coffee 130 call with more time in the anticipation that the market will trend higher, but not above the 130 strike before the first options on futures expiration. Some additional risk here lies in the difference between the two contract months. The objective is, if coffee trades higher over the next month but not above the 130 strike price, we’d collect the premium of the option we sold by letting it expire worthless. In addition, the option we purchased may also profit if coffee rises higher, but it may lose some value due to time decay if coffee doesn’t rally enough.