An option strangle involves purchasing a put (near the low of the underlying futures contract
's trading range) and simultaneously purchasing a call (near the high of the futures contract's trading range).
A sampling of terms defined includes: active premium, aggregation, angel financing, asset allocation, backwardation, benchmark, bridge loan, capital structure arbitrage, coefficient of determination, commodity option, convertible arbitrage, deferred futures, discretionary trading, distressed debt, enumerated agricultural commodities, extrinsic value, follow-on funding, hedge ratio, interdelivery spread, long short equity, modified value-at-risk, offshore fund, piggyback registration, social entrepreneurship, systematic trading, tracking error, underlying futures contract
, venture capital method, and weather premium.
A $150 call option gives the buyer the right but not the obligation to buy the underlying futures contract
at $150 a barrel.
The option will only be exercised if price movements are favorable to the option buyer, that is, if the underlying futures contract
would be profitable.
Before being used in the minimization of (7), the data were checked to make sure that they obeyed the inequality restrictions implied by the no-arbitrage conditions on American options prices: C [greater than or equal to] F - X and P [greater than or equal to] X- F, where F is the price of the underlying futures contract
. These conditions apply because an American option--which can be exercised at any time--must always be worth at least its value if exercised immediately.
We denote the market price of this contract by [[pi].sup.Z[wedge]c] ([F.sub.t],t) and assume that the futures cap has the same expiration date as the underlying futures contract
. We can safely assume that [[pi].sup.Z[wedge]c]([F.sub.t],t), otherwise [[pi].sup.Z[wedge]c]([F.sub.t],t) = c.
Options require less initial cash outlay than buying the underlying futures contract
would, but they can be much more volatile.
Also traded at the exchange are options that give the right, but not the obligation, to buy or sell an underlying futures contract
Assuming that all options are carried to expiration (no early exercise), a trader who buys the call and sells the put can always expect to end up with a long position in the underlying futures contract
An option on a futures contract derives its value from the underlying futures contract
, which in turn derives its value from the underlying cash, thus the name double derivative.
naked option writing--selling an option without owning the underlying futures contract
. Naked put writers are bullish and naked call writers are bearish.
Options on futures are traded at each of the futures exchanges and are standardized just like the underlying futures contracts
. Options on the physicals are nonstandardized, just like typical forward contracts.