Underlying Futures Contract

An underlying futures contract is the specific futures contract that serves as the basis for an option on that future. For example, an option on a U.S. Treasury bond futures contract at the Chicago Board of Trade (CBOT) would have the Treasury bond futures contract as its underlying future.
On this page

Definition

An underlying futures contract refers to the specific type of futures contract that is associated with and underpins an option. In financial markets, particularly within futures and options trading, the value of an option derives from the value of its underlying asset, which can range from commodities to financial instruments like bonds. The underlying future is crucial as it determines the terms and prices upon which the option is based.

For instance, on the Chicago Board of Trade (CBOT), there are options that utilize U.S. Treasury bond futures contracts as their underlying futures. In these instances, the Treasury bond futures contract represents the core asset upon which the associated options are constructed.

Examples

  1. U.S. Treasury Bond Futures Option: The CBOT offers options on U.S. Treasury bond futures. Here, the underlying futures contract is the Treasury bond futures.
  2. Gold Futures Option: On the COMEX (Commodity Exchange), options on gold futures are offered, where the underlying futures contract is the gold futures contract.
  3. Crude Oil Futures Option: The NYMEX (New York Mercantile Exchange) provides options on crude oil futures, with the underlying futures contract being the crude oil futures contract.

Frequently Asked Questions

Q1. What is the significance of the underlying futures contract in options trading? A1. The underlying futures contract determines the value and price behavior of the option. It is essential for setting the strike prices and expiration dates irrelevant to the underlying asset’s performance.

Q2. How do traders use underlying futures contracts in their strategies? A2. Traders use the underlying futures to hedge risks or speculate on price movements. For instance, instead of trading the futures directly, they may choose options to limit potential losses.

Q3. Are underlying futures contracts only related to commodity markets? A3. No, underlying futures contracts can also be based on financial instruments such as treasury bonds, stock indexes, and currencies.

  • Futures Contract: An agreement to buy or sell an asset at a future date at a predetermined price.

  • Option: A financial derivative giving the buyer the right, but not the obligation, to buy or sell an underlying asset at a set price within a specific period.

  • Strike Price: The predetermined price at which an option can be exercised.

  • Chicago Board of Trade (CBOT): One of the oldest futures and options trading exchanges, which offers a variety of derivative instruments.

Online References

  1. Investopedia: Futures Contract
  2. CME Group: Options on Futures
  3. Investopedia: Options
  4. Chicago Board of Trade

Suggested Books for Further Studies

  1. “Option Volatility and Pricing” by Sheldon Natenberg
  2. “Fundamentals of Futures and Options Markets” by John C. Hull
  3. “Trading Options Greeks: How Time, Volatility, and Other Pricing Factors Drive Profit” by Dan Passarelli
  4. “Futures, Options, and Swaps” by Robert W. Kolb, James A. Overdahl

Fundamentals of Underlying Futures Contract: Financial Derivatives Basics Quiz

Loading quiz…

Thank you for embarking on this journey through our comprehensive financial derivatives lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!

Underlying Mortgage
Underlying Debt