Futures

• Entering into a futures contract means you are obligated to abide by the agreement, unless you sell that obligation to someone else before the specified date. In the past, owning a future that reached maturity meant you’d have to take physical delivery of the product you agreed to purchase. But in modern times, you exit your position by selling a futures contract of the same type, either pocketing a profit or experiencing a loss, depending on the price difference between your initial purchase and current sale.
  
  

Futures Options

• In contrast, a futures option doesn’t involve an obligation to buy something later. Instead, it involves the right to purchase a futures contract for a specified price if you decide its profitable to do so. Essentially, when you buy a futures option, you pay the seller a small fee to allow you to make a decision later about buying a particular futures contract. If the value of the futures contract goes up later, you can exercise your option, allowing you to buy and then immediately sell the valuable futures contract, pocketing the difference between the old and new prices.
  
  

Risk

• But there’s a potential downside to investing in futures options: if you buy a futures option, but the going price of the underlying futures contract falls below the price you locked in, the option is worthless. At that point, it would make more sense to buy a new futures contract at the new, lower market price than exercise your option to buy a futures contract at the original, higher price. When the option expires, the seller keeps the money you spent.
  
  

Significance

• Imagine you had a feeling corn prices were going to rise in the next month, but you weren’t positive. Buying a futures option would lock in a price for a futures contract. If corn prices do increase drastically, you could sell your option for a profit. The person who sold you the futures option has the opposite hope: she wants the price of corn to drop so she can pocket your fee.
  
  

Considerations

• Futures and options are standardized, just like financial stocks, meaning you don’t actually enter into an agreement with any individual, though theoretically that is the underlying mechanism of the exchange. Instead, you invest in an open market, where many buyers and sellers speculate to make profits. If you believe prices will rise for a particular commodity or stock, you adopt what’s called a long position by buying a futures contract or a “call” option. If you believe prices will fall, you adopt a short position by selling a futures contract or buying a “put” option.