Forward start options are a unique style of option in which the strike price is unknown at the time of purchase. This trading guide will explain the fundamentals of forward start options, as well as providing definitions and examples of how these contracts function. Read on for details on their advantages and risks, some key strategies, and a step-by-step breakdown of how to start trading forward start options.
Below we list the top-rated brokers that offer retail options trading in 2023.
Forward Start Options 101
A forward start option is a type of exotic option in which the strike price is only set on the activation date, which is later than the date of purchase. The underlying asset, expiration date and activation date cannot be changed once the contract is purchased. The contract is customizable, meaning that the terms can be negotiated in advance of it being purchased.
The fact that the strike price is set in the future (at the activation date) is the only difference between a forward start option and a vanilla option. Once the strike price is set, it can no longer be changed.
Note that while futures are standardized contracts that can be traded on an exchange, forward start options are customized contracts that are not typically purchasable on central exchanges.
How Trading Forward Start Options Works
Trading forward start options is similar to trading regular options.
The key difference is that the strike price is unknown, and will only be established on the activation date.
The investor purchases an options contract on an underlying asset which means they have the opportunity (but are not obligated) to buy (call) or sell (put) the asset at a specified future activation date.Because the activation date can often be months in the future, the price is unknown by all parties involved in the contract.
Usually, the contract includes a rough idea of what the strike price will be in relation to the price of the underlying asset.For example, it could include that the strike will be 3% in-the-money (ITM) at the activation date.This makes the valuation of the premium is easier.
Example Explained
The easiest way to understand how these options work is through a detailed example.In this scenario, two participants agree to enter a call forward start options contract on Meta Inc. (formerly Facebook Inc.) stock.
Imagine it is 1st October 2018.The activation date of the forward start option is 90 days from the current date at-the-money (ATM), and the expiry date is set 6 months after the activation.This means that on the activation date the strike price will be known, and it will be the same as the trading price of the underlying asset.
The premium of the options contract can be decided by assessing historical market data on the volatility or volume of Meta Inc.shares.This data can be used to indicate the potential state of the share price at the time of activation.
The contract is finalized at a 50 USD premium for 100 shares, which is a total cost of 5,000 USD. 30th December 2018 is the activation date, as it is 90 days later.
On the activation date, the strike price is determined to be 500 USD and the option is now vanilla, and will expire in 6 months.
Whether the outcome will be profitable or not depends on the Meta Inc share price at expiry.
After the activation date, the option behaves like a vanilla option.
Benefits & Limitations Of Trading Forward Start Options
Benefits
- Can provide security when currency speculating
- Contracts are customized per negotiation, which can be better than standardized options contracts
- Sometimes the trader doesn’t have to make any payments until activation.If there is an initial fee written in the contract, it is called a margin
Limitations
- Potentially disorganized market as they are usually traded over-the-counter and not on exchanges
- No guarantee that a later strike price will be highly profitable
Strategy Tips
A strategy that can work well with forward start options is the married-put strategy.This involves the investor purchasing a regular put option of the same underlying asset as the forward start option.This acts as an insurance policy in the case that, at activation, the investor believes they could make a loss on their forward start options.
Therefore, the regular put option purchased with less risk attached (as the strike price was known) acts as a fail-safe.
How To Start Trading Forward Start Options
- Find a broker – In order to choose a broker that best suits your trading needs, it is important to be aware of any fees that they charge. You should also check what kind of customer service they provide and when they are available, whether it be 12 hours a day, 5 or 7 days a week, or 24/7. Research what kind of platform and market data they use, as not all brokers use popular apps like Thinkorswim, for example. Additional checks should include whether they offer more unique features such as access to percentage price oscillators (PPO), potential profit calculators, plus user-friendly charts and graphs. Also look at whether the broker or platform offers signals to help generate returns, quick quotes, multiple exercise options, and definitions of contract terms.
- Develop a strategy – Going into the trading day with a reliable strategy could make the difference between major gains or losses. Married-put is just one strategy out of many that already exist, but don’t limit yourself to that strategy alone. Many traders will combine strategies and tailor them to their requirements and trading style.
- You can also use indicators and charts to support your strategy, such as the 50 day moving average.
- Select an asset to trade – The final piece of the puzzle is choosing what you trade, whether it be Zoom Inc (ZM) shares, the Nasdaq Index, Bitcoin ETFs, or forex currency. Always do your research before settling on any asset to trade. Stay up to date on relevant news that can move the price of your asset.
Final Word On Trading Forward Start Options
Forward start options trading is a form of options trading which adds unknown variables to the investing process. At the time of purchase, the strike price of the contract is not known, and it is only established on the activation date in the future. The benefit of this type of contract is that both parties can agree to set the strike price at or near the money at the activation time. Use our guide to get started and always follow a strategy when trading forward start options.
FAQ
Is Forward Start Options Trading Halal?
Forward start options are arguably not halal due to the uncertainty resembling that of betting, which is restricted in Islam.
Check with your local mosque as rules differ amongst sects.
Is It Common For Brokers To Offer Forward Start Options Trading?
It is not common for brokers to offer forward start options trading in the USA, India or many countries. It is not available on Robinhood, Webull and Trade Zero, for example. See our list of brokers that offer retail trading options to get started.
What Assets Are Suitable For Forward Start Options Trading?
Forward start options trading is suited to many different assets, whether you want to go short or long. You could invest in AMC, Xela or Xle stocks, crypto coins, forex or even a group of stocks.
Can I Trade Forward Start Options In Excel?
While you cannot start trading forward start options in the Excel program for Windows 7, 10 and 11, it does allow you to keep track of your investments.