Note: Options involve risks and are not suitable for everyone. Option trading can be speculative in nature and carry substantial risk of loss. Only invest with capital you can afford to risk. And learn the basics of options trading before investing.

An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset (stock or future) at a specific price on or before a certain date (expiration date of the option). When you buy an option you only pay a premium and not the full price of the underlying stock or future, and the strike price is established. The strike price is the goal that you set to the price of the stock or future; where you think the price is going to be at or before the expiration date. The difference between the stock or future's current market price and the option's strike price represents the amount of profit per share gained upon the exercise or the sale of the option. The maximum amount that can be lost is the premium paid to buy the option.

Calls and Puts
The two types of options are calls and puts:

A call gives the holder the right to buy an asset at a certain price within a specific period of time. Calls are similar to having a long position on a stock or future. Buyers of calls hope that the price of the stock or the future will increase substantially before the option expires (expiration date).

A put gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock or future. Buyers of puts hope that the price of the stock or future will fall before the option expires.

Adding it Up
If you buy a call option and the price of the stock or future goes down, then at expiration date your option expire worthless and you loose the premium you paid to buy the call option.

If you buy a put option and the price of the stock or future goes up, then at expiration date your option expires wothless and you loose the premium you paid to buy the put option.

If you are trading a position (i.e. buying a call or a put), you need the market to have a chance of reaching a price that will make your option position profitable. When considering an option position, it is important to consider if it is probable that the market will reach that point. (strike price). Just because the premium paid is cheap or underpriced does not make the trade a good one, especially if the market has little or no probability of reaching that goal.

Options Trading Strategy
For options trading, simple is often better. Adhering to this principle when deciding whether or not an option position is a good trade, begin by calculating the average monthly range of the market. This number provides perspective on two important elements of an options trade: whether volatility is expanding or contracting and if the market has a chance of reaching and exceeding the break-even point of the position.

To calculate the average monthly range, you do not need any special software or a doctorate in mathematics. However, you will need access to reliable historical prices. Generally, for futures options calculations, you can use the free data available on the CME Group website and other financial websites or check with your BBCorp account manager.

The average monthly range is nothing more than an average price within which the market fluctuates in a given month between its high and its low. (More conservative traders could tighten this up and use the monthly open/close rather than the high/low.) To calculate this average for a given period of time, subtract the low from the high for each month to get that month's range. For the time frame, add up each month's range and divide by the number of months.

Selecting a Time Period
So how long of a period should be considered? Generally, it pays to look at a time frame of twice the length of the option position you are considering, and then break this up into two separate blocks of time. For example, if the option you are considering has three months of time to expiration, look at the average monthly range of the last three months, the three months prior to that and the last six months.

S&P Options on 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.

First go to the CME S&P 500 Index to look at prices and data. (OPT = options)

S&P futures trade in .10cent ticks (the minimum price change intervals), worth $25 each, so a full point ($1) is equal to $250. The Futures contract value of the S&P 500 index is $250 x market price of S&P 500. Delivery months are March, June, September and December and 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.

Let's consider an example: buy call option JUN S&P with strike price 1025. Futures rose six points from 1014 to settle at 1020.

This settlement price is 5 points away from Jun call strike price of 1025, which increases in value by $425. This near-the-money option has a higher delta (delta = 0.40) than options farther from the money, such as the call option with a strike price of 1100 (delta = 0.02), which increases in value by only $12.50. Delta values measure the impact further changes in the underlying S&P futures will have on these option prices. If, for instance, the underlying Jun S&P futures were to rise 10 more points to 1030, the S&P call option with a strike price of 1025 would rise by four points, or gain $1,000.

The same but reverse logic applies to the S&P put options.

Beirut Brokerage Corporation BBCorp S.A.L offers options trading by telephone and 24-hour-a-day broker/advisor support.