How to Calculate the Price for a Futures Option
Original post by Jessica Jones of Demand Media
Understanding the futures market can seem daunting at first, but once you learn how to read futures contract specifications, you will be able to make investment decisions. Investing in futures options is risky in that you must hope the trading price goes up or stays the same within a short time frame as contracts vary with some lasting only a month or two. Futures options include many industries such as agriculture, energy, currency and bonds.
Review the futures contract specifications of the futures you want to invest in to determine the quantity of one contract. The quantity is the number of shares you must purchase to invest in the contract. If you want to invest in corn futures and the quantity included in a contract is 5,000 bushels, then you must purchase 5,000 bushels. Futures contract specifications may be found online or by contacting your stock broker or investment adviser.
Determine the tick value of the futures option to better understand the minimum amount the stock price can fluctuate. Tick value is typically represented by a fraction -- in eighths -- and included at the end of trading price, which is always represented in cents. For example, if corn futures trade at 630-2, the trading prices is 630 and 2/8 (1/4) cents. The tick value for corn futures is 1/4 cents per bushel. This means for a corn futures contract with 5,000 bushels, the minimum stock fluctuation is $12.50 per contract. Understanding the minimum amount futures options fluctuate helps you make better assess risk potential.
Multiply contract quantity by the current trading price to calculate the price of a futures option. For example, if purchasing a corn futures contract with 5,000 bushels and trading price of 630-2, multiply 5,000 by 630.25 = 3,151,250 cents, which is $31,512.50.
Tips & Warnings
- Review markets carefully to compare current and past trading prices to determine which futures you feel comfortable investing your money in.
- TradingMarkets.com; How to Calculate Profit and Loss in Agricultural Futures; Carley Garner; November 2010
- FuturesMag.com; Buying Options Part 1: Reading Option Prices; Rick Thachuk; April 2009
- The Options Guide: Futures Trading Basics
About the Author
Based in the Washington metro area, Jessica Jones has been a freelance writer since 2006, specializing in business topics. Her fiction has also been featured in publications such as "The Jamaican Observer Sunday Literary Supplement" and at websites including HackWriters. Jones earned a Master of Fine Arts in fiction writing from Lesley University.