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Mark-to-Market Cash Flows When Exercising Options on Futures

Article Quant Q&A · Author: A.Oreo
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Summary

The document explains how exercise of a call option on a futures contract creates a futures position whose mark-to-market depends on its entry price. Because futures settle daily, the delivered position is treated as entered at the most recent settlement price, rather than at the earlier quoted futures price the questioner assumed.

The example separates the exercise-related amount, measured as settlement price minus strike, from the later futures gain when the contract’s price moves from settlement to the next spot price. Adding those cash flows yields the difference between the spot price and strike. The explanation is specific to futures options and daily settlement; it emphasizes that futures positions cannot be understood like stock holdings without accounting for the settlement-based entry price.

Key ideas

  • Exercise of an option on futures delivers a futures position marked from the last settlement price.
  • The futures position’s mark-to-market depends on its entry price, which daily settlement establishes.
  • Exercise-related value and the subsequent futures price change are separate cash flows.
  • In the example, the two cash flows combine to equal the spot price less the option strike.

Tags

FuturesOptionsDerivatives pricing
Full text
# What's the future price when you exercise the future option


# What's the future price when you exercise the future option












Here is the example of future option in John Holl's book `Options, Futures and Other Derivatives 9th` page 384.

I don't understand that when you exercise the future call option, you enter a long position of a future, then what's the price of your future? Actually, I don't much understand the `P&L on future` when you close out the future after exercise.

For my understand, you hold a long position of future with price $331,$ when you exercise, the price become $330,$ then you should `lose the money` $$25000\times(331-330)$$ but not `earn the money` in the book, so where is my misunderstand?

## Answer by Lliane (score 1)

https://quant.stackexchange.com/a/35593

This goes down to a specificity of options on futures. A future is not a stock, you need to know the entry price to compute the mark-to-market. You can't deliver a future/forward without specifying at which price it was entered. Futures are settled everyday so you will use the last settlement price as the entry price of the delivered future contracts.

Close of August 14th : 330 cents (settlement price of the future, SP)

Spot price on August 15th : 331 cents (spot price of the future, F)

If you exercice a call option on a future contract you receive the future contract + the (positive) difference between strike price and settlement price (10 cents). When you sell the future contract you receive the difference between the settlement price and the spot price (1 cent).

Cash received = (SP - K) + (F - SP) = F - K

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.