What is an option on a federal funds futures contract?
An option on a futures contract is an option where the underlying asset is a futures contract. Both put and call options can be traded on fed funds futures contracts. An option on a fed funds futures contract can be exercised any time at or before its specified expiration date. Options with this feature are known as American options. Options that can only be exercised at expiration are called European options. For simplification, the options are treated as if they were European when estimating implied probabilities. This simplification should have little material impact on the results. An option on a fed funds futures contract is distinguished by three features; the delivery date of the underlying futures contract, whether it is a call option or put option, and the strike price. An example is the call option written on the February 2006 futures contract with a strike price of 95.75. As is show in Appendix 1 of Recovering Market Expectations of FOMC Rate Changes with Options on Federal
