• Call option: Gives the buyer the right, but not the obligation, for a limited period of time to buy (go long) the underlying futures contract at a predetermined price.
• Put option: Gives the buyer the right, but not the obligation, for a limited period of time to sell (go short) the underlying futures contract at a predetermined price.
• Strike or exercise price: The price at which the futures contract underlying an option can be purchased (if a call) or sold (if a put). In the call and put definitions above, this is the predetermined price.
• Premium: The price paid by the buyer to the seller to purchase an option. This price is arrived at through trading on an exchange market, as with futures.
• Purchaser or holder: The person who buys a call or a put option and pays the option premium, i.e., the person who establishes a long options position. This is the party with the right, but not the obligation, under the terms of the option.
• Grantor: The person who sells a call or a put option and receives the option premium, i.e., the person who establishes a short options position. This party is obligated to perform under the terms of the option.
• Exercise: the exercise of a call gives the option purchaser a long position in the underlying futures con tract at the option’s strike price; the exercise of a put gives the option purchaser a short futures position at the option’s strike price.
• Assignment: The grantor of an option (the party with the short position) has agreed to be obligated by the Option’s terms should the purchaser or holder (the party with the long position) exercise the option? If the holder exercises, the grantor is said to be assigned, or to receive assignment.
• Time to expiration: The amount of time from the present until the end (expiration) date specified in the option contract.
• Expiration date: The last day that an option exists and can be exercised.
• American option: An option that can he exercised at any time up to and including the expiration date. Almost all options traded on U.S. futures exchanges are American style, as are a large percentage of options on futures traded outside the U.S.
• European option: An option that can be exercised only at its expiration.
• Underlying futures: Each option is the right to buy (call option) or sell (put option) a futures contract. Additionally, each option pertains to a specific futures delivery month. For example, the underlying future for a December T-bond call is a December T-bond futures contract, whereas the underlying future for a March T bond call is a March-Bond futures contract. Note, when option expirations do not correspond with futures expirations—e.g., a January ‘T-bond option—the underlying futures contract normally is the next futures contract to expire, e.g., the March T-bond. These latter are termed “serial” options.
  

Expirations
In the previous examples, the expiration of the option is not explicitly stated in its name. As indicated above, the month designations in the examples, December, November and September, refer to the delivery month of the underlying futures contract and not the expiration of the option, (This is a notable difference from the nomenclature used for stock options.)

Expiration dates of options on futures are set according to the rules and procedures of the exchange on which they trade, and there is no consistency between exchanges or even for various options on the same exchange. In particular, many options on futures expire well before the delivery month of the underlying futures; for example, a December crude oil option expires in November. On the other hand, a September S&P 500 option expires in mid-September. With serial options, expiration dates are even less evident. For example, a November ‘T-bond option, which has a December T-bond futures as the underlying contract, expires in October. As a result, it is critical to verify both the underlying futures contract and the expiration date of every options contract.

The same holds true for the short put. At expiration, a short put position has its maximum gain - the original option premium - if the underlying futures price is above the option’s exercise or strike price. While potential profits on a short put position are limited to the option premium, potential losses are virtually unlimited. However, because futures prices can only go to zero, losses are actually limited to the difference between the put’s strike price and zero, minus the premium received for selling the put.

• When the option’s strike price is equal to the futures price, both calls and puts are said to be “at-the-money”
• When an option has intrinsic value (when the strike price of the call is below the futures price or the strike price of the put is above the futures price), the option is termed “in-the-money.’
• When an option is neither at-the-money nor in-the money, (when the strike price of the call is above the futures price or the strike price of the put is below the futures price), the option is called “out-of the-money”

• Futures price;
• Option’s strike price;
• Time to expiration;
• Volatility of the futures price.

Options also are described as “wasting assets’ As time passes and an option approaches its expiration, the option’s time value declines to zero so that at expiration the only value left in an option—if any value remains— is its intrinsic value. The time decay (the way the option “wastes” over time) differs among at-the-money, In-the- money and out-of-the-money options. Note that the time value rapidly tapers off to zero, with almost all of the decay in the option’s value taking place during the last few weeks of its lift.

How much are the options on the two different underlying futures worth? The first options are easy to evaluate: if the final settlement price of the futures contract is known to be $100, then the 95 strike call will be worth $5 at expiration. Both the $100 and $105 strike calls, however will not be worth anything, because they will have no intrinsic value at expiration.

• Option prices do not move in lockstep with futures prices.
• Option prices can change even if the underlying futures price does not change, because option values are determined by factors In addition to the futures price.

Another way of looking at an option’s delta is that it it the percentage likelihood that the option will expire in- the-money. The $20 strike call has a 50-50 chance of expiring in-the-money and thus has a .5 delta. On the other hand, the $15 strike crude oil option may have a 99 delta because it has close to a 100 percent chance of expiring in-the-money. In contrast, near expiration the $25 strike call may have almost no chance of expiring in-the-money and have a delta near zero.

• Both puts and calls have deltas. Because puts increase in value when the futures price declines, the delta for a long put is always negative, ranging from 0 to -1, to., the put option price moves in the opposite direction to the price of the underlying futures contract. In contrast, the delta for a short put, which increases in value as the futures price rises, ranges from 0 to +1, the same as the delta for a long call position, that also increases in value as the futures price rises. (Correspondingly, the delta of a short call position ranges between 0 to -1.)
• Deltas are the same for changes in the futures price up or down. For example, if a (long) call’s delta is .5 and the futures fill 10 basis points, the call price can be expected to fall by about 5 basis points.
• Deltas vary; in a non-linear fashion, with changing levels of futures prices. As an option goes from being out-of-the-money to in-the-money, the absolute value of its delta increases.
• All other things equal, an increase in volatility will tend to push an option’s delta towards .50.This is because when volatility increases, all the strikes tend to look more and more like an at-the-money option. This point, however, is sensitive to the length of time remaining before an option’s expiration, as discussed below.
• Just before expiration, deltas tend to move towards either 0 or 1 (or -1); that is, they get extremely in- or out-of-the-money, because at expiration the option has to be either in- or out-of-the-money. As a result, just before expiration an at-the-money option’s delta will swing between 0 and I (or -1) as the option goes from out-of-the-money to in-the-money and hack again with fluctuating futures prices.
• The counterpoint to this is that, all other things equal, the more time an option has In Its life, the more it looks like an at-the-money option. This is because the more time remaining, the less certainty about whether the option will expire with Intrinsic value, thereby driving the delta towards 5 or 50 per cent and, hence, making it look more like an at-the- money option.
• Deltas are approximate numbers based on theoretical expectations about an option’s value; actual option prices often do not move exactly as predicted by an option’s delta, Figure 6.13 lists hypothetical deltas for (long) Eurodollar call options with the futures price at 91.50 and with various lengths of time remaining until expiration. Notice the symmetry in the table. Put deltas have a similar distribution (with negative Instead of positive deltas, as measured from the long side of the market) if the strike prices across the top were reversed in order.

Recall that a long futures position gains in value when die underlying futures goes up and decreases in value when the underlying futures goes down. In terms of the options payoff plots, a long call gains on the upside just as a long futures contract, while a short put loses on die downside just as a long futures position does. Thus, a long call and a short put in combination give the same payoff as does a long futures contract. This is called a “synthetic” long futures position. A synthetic short futures position can be created in a like manner. A short futures position gains when the underlying futures goes down, and It loses when the underlying futures goes up. The combination of a long put (which gains when the futures goes down) and a short call (which loses when the futures goes up) replicates a short futures position.

Exercise
The purchaser of either a call or a put has a long option position that can be exercised into a futures position. Upon exercise by a purchaser, a corresponding short is said to be assigned. The exercise of a long call results in the receipt of a long futures position at the strike price of the call plus an immediate marking to market of the difference between the current futures price and the option’s strike price (so long as the call has Intrinsic value). When a long call is exercised, the holder of a short call in the same option series (i.e., a call with the same strike price and expiration date on the same underlying futures contract) is assigned a short futures position, and that position also is marked to market. The exercise of a long put results In the receipt of a short futures position at the put’s strike price plus an immediate marking to market of the difference between the put’s strike price and the current futures price (so long as the put has intrinsic value). Similarly, the holder of a short put position is assigned a long futures position at the option’s strike price, and that position is marked to the market immediately.

• Because the most that can be obtained in exercising an option is the option’s intrinsic value, it makes economic sense to exercise only In-the-money options with little or no time value.
  As previously discussed, an American-style option can be exercised on any business day the option is traded, including the day it is purchased, up to and including the expiration date of the option.
• For options expiring on the same day as an underlying cash-settled futures contract, exercise on the last trading day results in a cash settlement of the option position, because the underlying futures contract terminates trading at the same time.
• The clearinghouse establishes an unbiased procedure for assigning exercised short option positions, such as random assignment of exercise notices to clearing member firms or assignment of the oldest position held by any clearing firm. The clearing firm then assigns the exercise notices to its clients by an approved selection process.
• Notice of assignment is given to the clearing member before trading begins on the day following an exercise notice.
• Many option contracts provide for automatic exercise of in-the-money options at expiration.
• When there is no automatic exercise, the buyer’s clearing firm must present an exercise notice to the exchange’s clearinghouse by the designated time for that contract on the exercise day.

The option that the long exercises Is exercised “against” the option grantor, who is short the option. In the first example above, the grantor of the gasoline call would receive a short gasoline futures position at the option’s strike price (60 cents/gallon), and that position would be marked to market immedlatel¾ with the option grantor’s loss of $1,680 passing to the option purchaser. In the second case, the option grantor would receive a long soybean oil futures position In the August contract at the 20 cents/pound exercise price, and that position would be marked to market immediately, leading to a $900 payment from the option grantor that the clearing house would pass through to the option purchaser.