Posted By: Ilan Levy-Mayer Vice President, Cannon Trading Futures Blog
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- Most futures options expire worthless and out of the money. Therefore, the option writer is collecting the premium the option buyer paid.
- 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.
- 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.
- 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.
Trading Futures, Options on Futures, and retail off-exchange foreign currency transactions involves substantial risk of loss and is not suitable for all investors. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources. You may lose all or more of your initial investment. Opinions, market data, and recommendations are subject to change at any time when it comes to Futures Trading.
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This is not a solicitation of any order to buy or sell, but a current market view provided by Cannon Trading Inc. Any statement of facts here in contained are derived from sources believed to be reliable, but are not guaranteed as to accuracy, nor they purport to be complete. No responsibility is assumed with respect to any such statement or with respect to any expression of opinion herein contained. Readers are urged to exercise their own judgement in trading.