An in-depth exploration of the underlying futures contracts, which serve as the basis for options on futures. This includes definitions, examples, historical context, applications, and related terms.
An Underlying Futures Contract is a futures contract that serves as the basis for an option on futures. This financial concept is pivotal in the domains of futures trading and options. For example, the Chicago Board of Trade (CBOT) offers U.S. Treasury bond futures options, where the underlying future is the Treasury bond futures contract itself.
Futures contracts are standardized agreements to buy or sell a specific quantity of a commodity or financial instrument at a predetermined price at a specified future date. They are traded on exchanges such as the Chicago Board of Trade (CBOT), enabling traders to hedge or speculate on future price movements.
Options on futures are derivative instruments that provide the holder the right, but not the obligation, to buy (call option) or sell (put option) a futures contract at a specified price (strike price) before or on a specified expiration date. The futures contract underlying the option determines the value and price movements of the option itself.
To illustrate, consider the following: The CBOT offers options on U.S. Treasury bond futures. The underlying future in this scenario is the Treasury bond futures contract. If an investor purchases a call option on these futures, they acquire the right to buy the Treasury bond futures contract at the strike price set within the option’s terms.
Investors and traders use underlying futures contracts primarily for:
Underlying futures contracts span a wide array of asset classes, including:
Options: Financial derivatives providing rights to purchase or sell the underlying asset. Futures: Standardized contracts for buying or selling assets at future dates. Derivatives: Financial instruments deriving value from underlying assets.