You can avoid many missteps if you keep track of the perfect reference price for Option Trades. Many factors affect the spot prices and cause the price to fluctuate and create sudden movements. Pricing can be said to be practical when you have Futures Prices as an underlying asset.
We understand that options are derivatives of the underlying asset but would it be practical to track spot price as a reference point in the actual market? Instead of Trading Options, tracking the futures as a reference point would be more practical. We shall understand this in more detail.
Futures Prices
Futures prices are the prices for the futures contracts with the predetermined payment and delivery dates for the future. These prices are agreed upon by the two parties for selling the asset and its delivery under a future contract.
You can go for future contracts for many financial instruments such as indexes. For Futures Prices, you write call options or put options believing in the direction that underlying will move towards,
When you buy options, you can benefit and make a profit by considering the movements of future contracts. But you need to pay up a little charge as a buying cost for actual futures. If you think the Futures Prices will raise then you may purchase a call. But if you believe that the price for futures will decline then you can buy a put option. The cost you pay for buying these options is known as Premium.
The future market includes instruments such as stock indexes, commodities and currencies, and some other stocks. Many investors consider the futures best suited for commodity trading. The Prices for Futures are for the potential buyers and the asset owner for doing transactions at some future date and pre-specified price.
Futures prices are based on the current spot price of the commodity and add some more costs that the seller will get when during the sale and expiration of the contract these additional costs include the fees for storage, transportation, insurance, and interest.
Spot Price
In Option Trades, the Spot price is the actual price of the current time and the one with instant payment. This is the price at which you can buy and sell securities at a specific place and at a specific time. Spot Price as the word suggests is for the current or actual market, not for the future, derivatives, and options.
There are always debates and discussions about the spot price vs. futures. When reaching the end of any debate, you will find that the spot price works best if you want to invest in the longer term.
To determine the Spot Price, you need to consider the demand and supply of specific assets that are being traded at the spot price. You will have to assume that the transaction takes place instantly. The current spot price is the base for the future commodity price.
If the price for futures is higher than the spot price, then the commodity price will probably be high.
Dividends affect Option Prices
The Option Prices model includes dividends which are counted at the time of expiration. During the expiration, when the value of the stock would fall along with the dividend. Option Prices are affected by the Cash dividends because they affect the underlying stock price.
People often ask if Option Trades are better than trading in stocks, then they should know that Option Prices are likely to be more volatile.
Interest Rates
The Interest Rates do not stay the same and they change frequently. These Interest Rates contribute to the Option Prices models as input. The future considers interest rates as very important if the futures are considered underlying. They are important factors that help you make the right decision for trading options or futures.
Market sentiment
Trading in the futures market can add more value to the dividends and interests. Due to the smaller deviations, many arbitrageurs do not prefer entering the trade after considering the cost of trading.
You cannot predict the market sentiments that might make a positive or negative impact on the futures or option prices but when the futures are taken as underlying, the market sentiment will start going to the option pricing.
Summary
The Option Trades can be more practical if you can consider the futures as underlying. Futures as underlying makes more sense compared to spots because you can reduce a lot of missteps and control the outcome.