# Trading Options in Futures Contracts



## bingk6 (4 September 2006)

Hi all,

I just came across an article in the latest YTE which compared stock options and futures options. In there, it mentioned that options in futures had lower margins, higher premiums and higher liquidity.

They gave an example of an investor selling a ATM Call on stock XYZ  for a premium of $200, and the need to post a margin of $1500 to $2000, yielding a ROI of approx 10%. 

However with futures, assuming coffee futures is at $1.03 per pound, a trader could write the call at $1.40 (Deep OTM) for $400 and needing to only post a margin of $800, yielding a ROI of 50%.

The interesting thing to note is that coffee futures write option is OTM by inexcess of 25%, and yet able to generate an attractive ROI. With stock options, unless you are writing options ATM, or 1 - 2 strikes OTM, you will end up with premiums that are worth, literally, peanuts (unless the stock has some incredible IV) .

My question is how does this happen??? If what the article says is true, all us stock option writers are trading the wrong instrument. I simply cannot understand how the futures options valuation do not follow the same valuation methodology as stock options   

Surely if we are to apply stock option valuation to the coffee futures example above, the IV would fly off into the stratosphere. But off course, it is possible to measure the historical volatility of coffee and it would be nowhere near the IV for the futures contract. Can somebody please explain this discrepancy to me


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## wayneL (4 September 2006)

bingk6 said:
			
		

> Hi all,
> 
> I just came across an article in the latest YTE which compared stock options and futures options. In there, it mentioned that options in futures had lower margins, higher premiums and higher liquidity.
> 
> ...




The return only looks good because of the margin expended. $400 premium is not a lot compared to the face value of the contract.

Writing futures option IMO IS far superior to writing stock options, but not without risks for the unwary.

I would cautiously encourage people to look at this, but proceed with extreme caution.

A great book to read on writing futures options is "Trading Options to Win" by Stuart Johnston.

http://www.moneybags.com.au/default.asp?d=0&t=1&id=4747&c=0&a=74

Here is the mean IV chart for coffee (this is dynamic and will update daily  )


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## wayneL (4 September 2006)

Here's a taste of how coffee can move 

104 ===>>> 320 in 5 months


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## wayneL (4 September 2006)

Current option chain on Dec coffee

A somewhat different story

http://www.futuresource.com/quotes/options.jsp?s=KCZ06&r=KC&style=Adjacent


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## NettAssets (4 September 2006)

wayneL said:
			
		

> Current option chain on Dec coffee
> 
> A somewhat different story




Do ya gotta go messin up a good yarn with FACTS


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## wayneL (4 September 2006)

NettAssets said:
			
		

> Do ya gotta go messin up a good yarn with FACTS




OOOOPs Sorry!

LOL


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## bingk6 (4 September 2006)

Greetings Wayne,

Unfortunately for the example in the article, they did not provide any expiry periods. However, assuming that they did provide the expiry, we should then be able to calculate the IV. One would reasonably expect this calculated  IV value to bear some resemblance to the historical volatility for the commodity (coffee, in this case).

To write a stock option that is OTM by 25% and still generate a "reasonable" premium would have required one hell of an IV, and whilst the chart that you attached showed that coffee is a volatile creature, would it come anywhere near its calculated IV ??

I don't trade futures options and so have no real example to do some calculations with, but would welcome anybody providing a real life example, with the full set of numbers so that we can examine a specific example.

Bingk6


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## wayneL (4 September 2006)

Going by the numbers provided expiry would most likely be in excess of 60 days.

Just to clarify one point. IV/SV relationship is the same for futures and stocks. IV skews may be different because of the perception of where likely fat tail events might be.

The only structural differences lie in margin (as discussed) and in the cost of carry component of option pricing. (the option is an option on a contract rather than on an asset, therefore the cost of carry is mostly priced into the future)

As much as I really do prefer futures options over stock options, it looks as though there was a bit of shenanigans in the article.

Like I said, do consider, but be aware of ALL the risks.


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## wayneL (4 September 2006)

Here is the chart of the current dec contract with SV below.

Compare with the IV mean chart I posted above...

Opportunity   But I want to keep stressing the risks and having the skills to manage them


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## CanOz (3 January 2015)

I'm just spending my lazy Saturday night trying to learn about options on futures. If i want to play the bearish break on CC, can i buy a march put (CC FOP (CO) Mar'15 2850 PUT @ Nybot)? This gives enough time to expiry, my risk is limited to like 322.00 odd USD, the reward is unlimited.

Really a noob at this one, just playing on the IB Sim.

I was looking for a way to trade my directional biases on Futures without needing a 100k account to do so, trying to keep my risk to less than 1%.

CanOz


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## hhse (3 January 2015)

wayneL said:


> The return only looks good because of the margin expended. $400 premium is not a lot compared to the face value of the contract.




I've never traded options on futures. So to clarify, are you saying that options on futures are highly leveraged products when compared to normal options, and thus you get a better ROI, but taking on board significantly more risk.


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