Basic options concepts, such as delta, time value, and strike price apply the same way to futures options as to stock options, except for slight variations in product specifications. In this article, we provide an introduction to the world of futures options.
Key Takeaways
- Options on the S&P 500 index are among the most popular and widely used by investors, speculators, and hedgers.
- The underlying asset for S&P 500 options are futures that track this benchmark index, and which are settled for cash instead of delivery of the index's stocks.
- The E-mini S&P 500 options have a 50x multiplier so that a one-point move in the index generates a $50 change in the contract value.
Stock Index Options on Futures
The first thing that probably throws a curveball at you when initially approaching options on futures is that you may not be familiar with a futures contract—the underlying instrument upon which options on futures trade. Recall that for stock options, the underlying is the equity issue (e.g. IBM call options trade on IBM stock). Since most investors understand how to interpret stock prices, figuring out the underlying is easy.
When learning futures options, on the other hand, traders new to any particular market (bonds, gold, soybeans, coffee or the S&Ps) need to get familiar not only with the option specifications but also with the product specifications of the underlying futures contract. These, however, are insignificant obstacles in today'senvironment, which offers so much information just a click away. This article will explain how S&P 500 futures options work.
Options on S&P Futures
To illustrate how options on futures work, I will explain the basic characteristics of S&P 500 options on futures, which are the more popular in the world of futures options. Although these are cash-based futures options (i.e. they automatically settle in cash at expiration), the logic of S&P futures options, like all futures options, is the same as that of stock options. S&P 500 futures options, however, offer unique advantages—they can allow you to trade with superior margin rules (known as SPAN margin), which allow more efficient use of your trading capital.
Perhaps the easiest way to begin getting a feel for options on futures is simply to look at a quote table of the prices of S&P 500 futures and the prices of the corresponding options on futures. Essentially, the principle of the pricing of S&P futures is the same as that of the price behavior of any stock. You want to buy low and sell high. In other words, if the S&P futures rise, the value of the contract rises and vice versa if the price of S&P futures fall.
Differences and Characteristics Between S&P 500 Futures & Options
S&P 500 futures are contracts that obligate the buyer and seller to trade the S&P 500 index at a predetermined price and date in the future. They are standardized and traded on the Chicago Mercantile Exchange (CME), and are settled to cash. S&P 500 futures are often used to hedge, speculate, or arbitrage on the movements of the U.S. stock market.
Options on S&P 500 futures are contracts that give the buyer the right, but not the obligation, to buy (for a call options) or sell (for a put option) the underlying S&P 500 futures contract at a specified strike price and expiration date. They are also standardized and traded on the CME for cash settlement. Options on S&P 500 futures are used to create various strategies that can profit from different market scenarios, such as volatility, direction, or time decay.
People also can trade options on SPY are contracts that give the buyer the right, but not the obligation, to buy or sell the SPY ETF, which tracks the performance of the S&P 500 index, at a specified strike price and expiration date. ETFs trade like stocks and are often more accessible for ordinary investors than futures or options on futures. SPY options are standardized and traded on various options exchanges, such as the CBOE, and are settled by physical delivery of the SPY shares.
Key Differences
As the table shows, there are some key differences to keep in mind. For instance, futures contracts require margin while options contracts cannot be traded on margin. Options also give holds the right, but not the obligation to trade the underlying security - while futures contracts oblige the holder to do so at expiration.
S&P 500 futures track the index, but there are often small differences between the futures price and the index value, or what is known as the basis. Since options on S&P 500 futures options trade on the underlying futures, the level of S&P futures, not the S&P 500 stock index, is the key factor affecting the prices of options on S&P futures.
Another thing to keep in mind is the tick size. The tick size is the smallest possible price change that a stock, futures, or options contract can experience, while the tick value is the dollar value of that price change. It is set by the exchange, and it varies according to the futures contract you’re trading. For example, the tick size of an S&P 500 Futures contract is 0.25 index points, with a tick value of $62.50. also have a tick size equal to one quarter of an index point, but because they are smaller contracts it is valued at $12.50 per tick. The tick size of an option on S&P 500 or E-mini futures will be the same as the underlying contract. The tick size of an option on SPY is 0.01, or $1 per tick, since SPY shares move in one-cent increments and options on SPY represent 100 shares per contract. Knowing the tick size and value can help you calculate the profit or loss of your trades, as well as the margin requirements and the liquidity of the market.
| S&P 500 Futures vs. Options | |||
|---|---|---|---|
| Feature | S&P 500 Futures | Options on S&P 500 Futures | SPY Options |
| Definition | Contracts to buy or sell the S&P 500 index at a future date at a predetermined price. | Contracts that give the right, but not the obligation, to buy or sell S&P 500 futures at a set price before the contract expires. | Options that give the right, but not the obligation, to buy or sell the SPY ETF (which tracks the S&P 500 index) at a set price before the option expires. |
| Underlying Asset | S&P 500 index | S&P 500 futures contracts | SPY, an ETF that tracks the S&P 500 index |
| Market Focus | Hedging and speculation on the overall market direction of the S&P 500 index. | Hedging and speculation with leverage on the future price movements of the S&P 500 futures. | Investment and hedging strategies directly related to the price movements of the S&P 500 index, through the SPY ETF. |
| Trading Venue | Futures exchanges (e.g., CME) | Futures & options exchanges where S&P 500 futures are traded | Options exchanges (e.g., CBOE) |
| Settlement | Cash settlement based on the index value at expiration. | Cash settlement, but the outcome is based on the value of the S&P 500 futures contract. | The exchange of the underlying SPY shares upon exercise, unless traded out or expired. |
| Contract Size | Standardized (e.g., $250 times the index) | Standardized, based on the futures contract it is derived from. | Standardized, typically 100 shares of the SPY ETF per option contract. |
| Tick Size | The minimum price movement is set at 0.25 index points, equivalent to $62.50 per contract. | Matches the tick size of the underlying futures, reflecting minimal price changes in the option's value. | Typically $0.01 per share for the SPY option, translating to $1.00 per contract. |
| Liquidity | High, due to the broad market interest in the S&P 500. | Varies, but generally less than the underlying futures due to the added complexity. | High, as SPY is one of the most actively traded ETFs, making its options widely used. |
| Margin | High, allows control of large positions with a relatively small capital outlay using margin. | Options premium must be paid in-full | Options premium must be paid in-full |
| Risk Level | High, due to leverage and the potential for significant losses w/margin calls. | Moderate, has limited downside but they can become worthless if the futures price does not move beyond the strike price by expiration. | Moderate to low, depending on whether the option is bought (where risk is limited to the premium paid) or sold (where risk can be more significant). |
Benefits & Risks of Trading S&P 500 Futures
Benefits
Trading S&P 500 futures offers a range of advantages for investors and traders. One of the most significant benefits is the ability to hedge against market volatility. By taking positions opposite to those held in the cash market, investors can protect their portfolios from adverse movements. Additionally, S&P 500 futures provide substantial liquidity, ensuring that large positions can be entered and exited with minimal slippage, making it easier to implement strategies at desired price points.
The high leverage available in futures trading allows for a greater degree of capital efficiency. Traders can control large positions with a relatively small amount of capital, amplifying potential returns on investment. Moreover, the futures market is accessible nearly 24 hours a day, offering the flexibility to respond to global economic events as they unfold. This round-the-clock trading capability means that investors can adjust their positions in response to news that might affect the market outside of standard trading hours.
Risks
While trading S&P 500 futures can be lucrative, it also comes with significant risks. The very leverage that amplifies gains can also magnify losses, potentially resulting in the loss of more than the initial investment. This aspect of futures trading underscores the importance of risk management strategies, such as using stop-loss orders to limit potential losses.
Market volatility, while it can be hedged against, also poses a risk, as rapid price movements can lead to substantial losses in a short period. Furthermore, the nearly 24-hour trading environment, while beneficial, can also lead to the temptation of overtrading or the stress of feeling the need to constantly monitor positions. This can not only impact decision-making but also lead to burnout. Additionally, the complexity of futures contracts and the requirement to understand not just the market but also specific contract specifications, such as expiration dates and settlement procedures, can be daunting for less experienced traders.
Benefits & Risks of Trading S&P 500 Futures
Benefits
Options on S&P 500 futures offer unique advantages distinct from trading the futures directly. A key benefit is the flexibility they can provide. As mentioned, options grant the right, but not the obligation, to buy or sell a futures contract at a predetermined price, offering strategies to profit from various market conditions—upward, downward, or sideways. This flexibility allows traders to structure positions with predetermined risk and reward profiles, tailoring strategies to their risk tolerance and market outlook.
Moreover, options on S&P 500 futures can offer a cost-efficient way to gain exposure to the S&P 500 index. Since buying an option typically requires a smaller initial investment than the margin needed for a futures contract, traders can control the same amount of exposure with less capital, enhancing leverage. This can be particularly advantageous for hedging purposes, as options can be used to protect against downside risk in a portfolio with a relatively low upfront cost.
Options also provide a degree of risk limitation that is not available when trading futures directly. When buying options, the maximum risk is limited to the premium paid for the option, regardless of how adverse market movements may be. This contrasts with futures, where the potential for loss can significantly exceed the initial margin if the market moves unfavorably.
Risks
While options on S&P 500 futures provide several benefits, they also carry specific risks not as pronounced when trading futures directly. One such risk is the complexity of options. The value of an option is influenced by multiple factors, including the underlying futures price, volatility, time decay, and interest rates. This complexity requires a thorough understanding to predict how changes in these factors affect option pricing and, by extension, trading outcomes.
Another risk is the impact of time decay on options. All else being equal, the value of an option decreases as it approaches expiration due to the eroding time value. This aspect of options trading means that even if the market moves in the anticipated direction, the option’s value might not increase enough to result in a profit after accounting for the premium paid. This contrasts with futures, where no time decay factor directly impacts the contract's value.
Additionally, while the upfront cost of purchasing an option is lower than the margin requirement for a futures contract, this premium is a sunk cost that is lost if the option expires worthless. This potential for 100% loss of the premium requires careful consideration and risk management, particularly in volatile markets where the probability of options expiring out of the money may be higher.
Steps to Trading Options on S&P 500 Futures
The first step to trading options on the S&P 500 is gaining a solid understanding of the options and futures markets, including the terminology and mechanics of how these instruments work. This foundation is very important for making informed decisions.
Next, setting clear trading objectives is important. Whether the goal is hedging, speculation, spreading, or income generation, having a strategy in place can guide the selection of the right options contracts to meet those aims.
After objectives are set, choosing a reputable broker that offers access to the futures and options markets is essential. This broker should provide easy-to-use and comprehensive trading platform, tools for analysis, and research & educational resources to support trading activities. You will have to be approved for trading on margin, trading futures, and trading options. Some may not be qualified or have sufficient account funds for approval, but you may still be able to get options approval to trade SPY options.
Before executing any trades, it's essential to develop a risk management plan. This includes determining the size of positions, setting stop-loss levels, and deciding on profit targets to manage potential losses and protect gains effectively. Additionally, continuous learning and adaptation are also important, as the market's conditions change over time. Successful traders regularly review their strategies, stay informed about market developments, and adjust their approaches as necessary to align with the evolving market environment.
Example
Let's take a closer look at S&P futures and options prices, particularly at how changes in the price of futures affect changes in the prices of the option. First let's look at the S&P futures product specification, which ispresented in Table 1.
| Table 1: S&P Futures Product Specification | ||||
|---|---|---|---|---|
| Futures Contract | Contract Value | Tick Size | Delivery Months | Last Trading Day |
| E-Mini S&P 500 | $50 * price of S&P 500 | .25 in premium = $12.50 in notional value | March, June, Sept. and Dec. | Thursday prior to the third Friday of the contract month |
S&P E-Mini futures trade in ticks of 0.25 points worth $12.50 each, so a full point is equal to $50. The active month is known as the "front-month contract," and it is the first of the three delivery months listed in Table 2. The last trading day for all S&P futures contracts is on the Thursday before expiration, which is on the third Friday of the contract month.
| Table 2: Settlement Prices | ||||
|---|---|---|---|---|
| Contract | High | Low | Settlement | Point Change |
| June 2024 | 4385.75 | 4380.00 | 4390.50 | -65.00 |
For example, the June S&P futures contract in Table 2settled at 4390.50. The point change of -65.00 is equivalent to a gain of $3,250 per single contract (-65 x $50 = $3,250). It is worth noting that the S&P futures and the S&P 500 stock index will trade nearly identically, but the S&P futures will trade with a slight premium attached.
Now let's turn to some of the corresponding options, where there is a uniformity of pricing between the futures and options. That is, the value of a $1 change in premium is the same as a $1 change in the futures price. This makes things easy.
Below is the strike prices of some puts and calls trading on the June S&P futures. Just as we would expect for stock put and call options, the delta in our examples below is positive for calls and negative for puts. Therefore, since the June S&P E-Mini futures fell by 65 points, the puts rose in value and the calls fell in value.
:max_bytes(150000):strip_icc()/eminioptions-c8a2a64cc63f47fcab749baead93b8c0.jpeg "An Introduction To Options On S&P 500 Futures (1)")
Can You Buy Options on the S&P 500 Index?
While you can buy options on the index directly, you can buy options on S&P 500 futures contracts, which track the index. You can also buy options on the SPY ETF, an exchange-traded fund that also tracks the S&P 500 index.
Is it Cheaper to Trade Options Instead of Futures?
The cost of trading options versus futures will vary depending on several factors, including the size of the position, market conditions, and the specific strategy being employed. Options may require a lower initial capital outlay since you're typically paying only the premium to buy the option, not the full value of the underlying asset as in futures trading. Options that are farther out-of-the-money will have lower premiums, and thus cost less. However, this premium can also represent a cost that might not be recouped if the market doesn't move in your favor. Futures, on the other hand, can often be bought on margin - which also reduces the initial outlay, but may require adding additional money to the account if the market moves against you.
How Can S&P 500 Futures Be Used to Hedge?
Traders can use S&P 500 futures to hedge against market volatility and protect their portfolios from adverse movements. For example, an investment manager fearing a market decline might short S&P 500 futures. If the market does fall, the gains from the futures position can offset losses in the portfolio.
When Were S&P 500 Futures Options First Introduced?
S&P 500 futures were first listed on April 21, 1982, on the Chicago Mercantile Exchange (CME). This introduction marked a significant milestone in financial markets, offering investors a new way to hedge against market volatility or speculate on the future direction of the overall market. E-mini futures were introduced in 1997.
Options on S&P 500 futures were introduced several months after the original futures contracts, on July 1, 1983 on the CBOE.
The Bottom Line
While there are many ways to trade using these options, many traders prefer to be a net seller of options. Whether you prefer to buy or write (sell) stock options using either simple spreads or more complex strategies, you can, with the basics presented here, easily adapt many of your favorite strategies to S&P options on futures.
Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy.
CME Group. "E-mini S&P 500."
CME Group. "2017 Product Anniversaries."
Reuters. "Timeline: Key dates and milestones in the S&P 500's history."
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Part Of
Guide to Futures Trading
- The Investor’s Guide to Futures1 of 20
- Futures in the Stock Market: Definition, Example, and How to Trade2 of 20
- Futures Contract Definition: Types, Mechanics, and Uses in Trading3 of 20
- Futures Exchange: Overview of How it Works, History4 of 20
- What Are Index Futures? Definition, Types, and How to Profit5 of 20
- Commodity Market: Definition, Types, Example, and How It Works6 of 20
- What Is an Interest Rate Future? Definition and How to Calculate7 of 20
- Energy Derivatives: What They Are, How They Work, Example8 of 20
- Trading Gold and Silver Futures Contracts9 of 20
- Trading the Soft Commodity Markets10 of 20
- Bond Futures: What They Are, How They Work, and How to Buy Them11 of 20
- A Quick Guide for Futures Quotes12 of 20
- Interpreting Volume in the Futures Market13 of 20
- Intro to Open Interest in the Futures Market14 of 20
- Forward Contracts vs. Futures Contracts: What’s the Difference?16 of 20
- Risk Management Matters in Futures Trading17 of 20
- How Risky Are Futures?18 of 20
- How Are Futures Used to Hedge a Position?19 of 20
- An Overview of Futures20 of 20
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