Options  |  MAY 2009

Options On Futures by John Jay Norris

Options On Futures by John “Jay” Norris Here’s how to identify the appropriate underlying conditions and timing for option strategies. The first two things industry insiders will tell you about options on futures is that more than 80% of them expire worthless, and that selling naked options on a monthly basis is frequently referred to as “picking up dimes in front of a steamroller.” Put those together and you get losses more often than not if you buy them or you get paid a meager sum on a regular basis if you sell them, and hope you figure out a better way quickly before you get crushed by the steamroller. Trading futures and options on futures carries a substantial risk of loss and is not suitable for every investor. As with any type of investment, you have to do your homework and understand the risks. DRIVE THE STEAMROLLER In my opinion, the “better” way is to use options in conjunction with the opposite position in the underlying futures contract, or when a market is starting to experience a long-term trend shift and an attractive risk/reward ratio justifies the possibility of a small loss. These strategies can mean you still sweep up those dimes but you don’t have to worry about the steamroller or, even better, set yourself up to drive the steamroller. Before we get into option strategies that might apply to setups and situations in the markets you follow, we need to define the basic instruments and terms used. An option is a derivative product of a security, commodity, or other financial product that allows the holder or buyer the right to control the underlying product at a specific price at a future date. Once that date passes, the option is either exercised, meaning that the option holder takes control of the asset because price is beyond the price specified in the option, or the option expires worthless because the price did not reach the point specified in the option. Over the course of its life, the option will fluctuate in price, as will the price of the underlying product.

by John Jay Norris