When trading options on futures contracts, the number of choices available—delivery months and options expiration dates—can be overwhelming. Follow the volatility curve to help you whittle it down.
Futures traders learn early that for each listed product, there are multiple contract delivery months. And if you trade options on those futures, you quickly figure out that those options are tied to different contract delivery months depending on an options contract’s expiration date and the last trading day of the next futures contract. Options on futures are different from equity options, which settle into the underlying stock.
For example, the CME Group lists monthly crude oil futures contracts (/CL). There’re several options contracts on those futures with expiration dates tied to each contract. If you’re just starting out, that may sound overwhelming. To an experienced futures trader, it can mean more flexibility and targeted exposure.
Say you’re looking at a chart of /CL. You’ve identified what you think is a lower bound or support level, and you’d like to sell a put option. If the price doesn’t move or rallies, you could pocket the premium from the short put (minus transaction costs). If the price dips below the strike at or before expiration, you may consider going long crude.
The mechanics are similar to equity options—strike price and expiration date—but there’s an extra consideration. With futures options, you need to know which futures contract an option will settle into. The top section of figure 1 shows three crude futures contracts: Sep (/CLU19), Oct (/CLV19), and Nov (/CLX19). Notice the prices of further expirations are higher. This indicates the futures curve is upward-sloping.
In this example, the futures curve slopes slightly upward, meaning deferred months are slightly higher in price than near term contracts. And the price difference between contracts is only a few cents. But sometimes the difference can be greater and affect options prices, which in turn can affect strike selection.
If you’re trying to decide which contract to trade, consider comparing volatility (vol). If you’re looking to sell a put, you may want to start with one that’ll give you a vol boost.
When do you initiate a short put strategy? Which strike should you choose? One approach is to use a linear regression channel—a technical indicator that can offer clues to help you identify overbought and oversold conditions (see figure 2).
There are two ways to use a linear regression channel in a short put strategy:
There’s no guarantee that linear regression lines will correctly identify reversals. Things change. But when it comes to options on futures, you can pair this kind of indicator with a vol-curve assessment to help you decide how to time an options trade and which strike to choose.
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