A customer can predict the direction of the market underlying an option and still lose money. Timing, strike price, and premium determine the result.
A futures contract is a standardized, exchange-traded agreement obligating a buyer and seller to transact later at an agreed price. The underlying asset is what the contract references, such as wheat, Treasury securities, or a stock index. The contract establishes a future purchase or sale price before the asset is needed.
Standardization fixes quantity, quality where relevant, and settlement arrangements. The parties need not negotiate every term privately. The buyer holds the long position; the seller holds the short position. Rising futures prices benefit the long and hurt the short. Falling prices reverse those results.
The short seller and long buyer must transact under the futures contract unless they close their positions before final settlement. Depending on the contract, they deliver and receive the asset or settle in cash. Cash settlement replaces delivery with a payment; a losing party must still perform.
Common mistakes
- Treating a $6,000 futures margin deposit as a maximum loss. The performance obligation can require additional cash.
- Confusing a $300 option premium with the $5,000 needed to exercise a standard $50 call. They pay for different things.
- Reporting $200 profit when a $3 call expires with $2 intrinsic value. The actual result is a $100 loss per standard contract.
Bottom line
- Futures bind both parties unless their positions are closed before final settlement.
- Futures margin is a performance deposit, and daily marking to market transfers gains and losses.
- A call holder may buy at the strike; a put holder may sell at the strike.
- An assigned option writer must perform, and premium received does not cap the writer's loss.
Exam shortcut
Identify the instrument and circle the customer's role before calculating. “Buyer” creates different responsibilities in futures and options. For margin questions, calculate the trading gain or loss first, then the account balance, then any funding requirement. Keep deposits outside trading profit. For options, separate strike, premium, contract size, exercise date, and settlement method. Calculate per share first, then multiply. When stock and options appear together, combine initial cash flows once.
The full lesson (about 2,625 words, 18 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- B7
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