UK Accounting Glossary
A futures option is an option on a futures contract. The futures option is common for both commodity futures such as wheat and coffee contracts and financial futures such as Japanese Yen and S&P 500 Index contracts. The key difference between a futures option and an option on a futures contract’s underlying asset is delivery convenience. A futures contract for 1000 barrels of oil is much easier to deliver than the oil itself. Upon exercise of the futures option, the delivered futures contract is typically closed out immediately. The futures option is therefore typically settled entirely in cash. Cash settlement of the futures option appeals to investors with insufficient capital to purchase the underlying asset. The close coupling of futures and futures option markets facilitates hedging, speculation, and arbitrage, making the markets more efficient. Fischer Black developed a model to price the futures option in 1976.
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This glossary post was last updated: 9th February 2020.