49 lines
4.3 KiB
Plaintext
49 lines
4.3 KiB
Plaintext
479
|
||
AN INTrOduCTION TO OPTIONS ON FuTureS
|
||
between the futures price and the strike price were less than the premium paid for the option, the
|
||
net result of the trade would still be a loss. In order for the call buyer to realize a net profit, the dif-
|
||
ference between the futures price and the strike price would have to exceed the premium at the time
|
||
the call was purchased (after adjusting for commission cost). The higher the futures price, the greater
|
||
the resulting profit. Of course, if the futures reach the desired objective, or the call buyer changes his
|
||
market opinion, he could sell his call prior to expiration.
|
||
4
|
||
The buyer of a put seeks to profit from an anticipated price decline by locking in a sales price.
|
||
Similar to the call buyer, his maximum possible loss is limited to the dollar amount of the premium
|
||
paid for the option. In the case of a put held until expiration, the trade would show a net profit if the
|
||
strike price exceeded the futures price by an amount greater than the premium of the put at purchase
|
||
(after adjusting for commission cost).
|
||
While the buyer of a call or put has limited risk and unlimited potential gain,
|
||
5 the reverse is true
|
||
for the seller. The option seller (“writer”) receives the dollar value of the premium in return for
|
||
undertaking the obligation to assume an opposite position at the strike price if an option is exercised.
|
||
For example, if a call is exercised, the seller must assume a short position in futures at the strike
|
||
price (since by exercising the call, the buyer assumes a long position at that price).
|
||
upon exercise,
|
||
the exchange’s clearinghouse will establish these opposite futures positions at the strike price. After
|
||
exercise, the call buyer and seller can either maintain or liquidate their respective futures positions.
|
||
The seller of a call seeks to profit from an anticipated sideways to modestly declining market. In
|
||
such a situation, the premium earned by selling a call will provide the most attractive trading oppor-
|
||
tunity. However, if the trader expected a large price decline, he would usually be better off going
|
||
short futures or buying a put—trades with open-ended profit potential. In a similar fashion, the seller
|
||
of a put seeks to profit from an anticipated sideways to modestly rising market.
|
||
Some novices have trouble understanding why a trader would not always prefer the buy side of an
|
||
option (call or put, depending on his market opinion), since such a trade has unlimited potential and
|
||
limited risk. Such confusion reflects the failure to take probability into account. Although the option
|
||
seller’s theoretical risk is unlimited, the price levels that have the greatest probability of occurring
|
||
(i.e., prices in the vicinity of the market price at the time the option trade occurs) would result in a net
|
||
gain to the option seller.
|
||
roughly speaking, the option buyer accepts a large probability of a small loss
|
||
in return for a small probability of a large gain, whereas the option seller accepts a small probability
|
||
of a large loss in exchange for a large probability of a small gain. In an efficient market, neither the
|
||
consistent option buyer nor the consistent option seller should have any advantage over the long run.
|
||
6
|
||
4 even if the call is held until the expiration date, it will usually still be easier to offset the position in the options
|
||
market rather than exercising the call.
|
||
5 T echnically speaking, the gains on a put would be limited, since prices cannot fall below zero; but for practical
|
||
purposes, it is entirely reasonable to speak of the maximum possible gain on a long put position as being unlimited.
|
||
6 T o be precise, this statement is not intended to imply that the consistent option buyer and consistent option seller
|
||
would both have the same expected outcome (zero excluding transactions costs). Theoretically, on average, it is rea-
|
||
sonable to expect the market to price options so there is some advantage to the seller to compensate option sellers for
|
||
providing price insurance—that is, assuming the highly undesirable exposure to a large, open-ended loss. So, in effect,
|
||
option sellers would have a more attractive return profile and a less attractive risk profile than option buyers, and it
|
||
is in this sense that the market will, on average, price options so that there is no net advantage to the buyer or seller. |