Online Commodity Futures

Posts Tagged ‘commodity trading’

Commodity options offer the option holders the right to buy and sell commodities at the specified rates within a specific time. The commodity options are offered in several over-the-counter markets and exchanges. Helping people to ensure against the price volatility is the main function of these options.

There are two main varieties of commodity options. These are called call and put options. Over-the-counter markets offer different varieties of them. They can be defined as the contracts that allow the buyers an option, the right not an obligation for buying and selling at specific rate with the specified date. The most important feature of these options is that they do not obligate either of the parties. This can be called as the most important difference between a futures contract and an options contract.

Futures contracts obligate both parties to abide by the terms of the contract. The options may be written for the underlying assets including financial indexes and financial instruments. However, if the underlying assets are commodities like precious metals, grain, oil and other agricultural products, the options will be called commodity options.

The main factor that differentiates the options is the criteria whether they offer the ‘buyer of option’, the right to buy or sell the commodity at rates that are specified before their expiration date. The options that offer a right to buy are known as call options whereas the ones that offer a right to sell are known as put options.

An options contract must specify certain things including the commodity being traded, whether the options are call or put, number of units being traded, the expiration date and the strike price fundamentally. In brief, commodity options are a great help to traders as they offer an insurance against the price volatility.

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I want to go over a common concern with futures options trading. I only recommend and teach selling options if you are covering them by buying options. Sold options that are not covered are called “naked options”. That means that if there is a move against you, and you did not also buy options, there is potential unlimited loss.

If you did cover your sold position by buying a future option as protection, you are no longer naked. Now even if a sold option is covered some still feel nervous if an option they sold is exercised into a futures contract. The buyer of an option has the right at any time to exercise their option. Let’s assume you sold a call option to someone. They exercise the option and now they are long a futures. That means you are short the futures. Should you be concerned?

Two things to consider:

You have unlimited loss potential whether you are selling a futures option or long or short a futures contract. So the fact that someone exercises an option should not worry you more. Either way, you have unlimited loss potential. But you always want to cover the position. So either way, now that it is covered, you do not have unlimited loss potential.

The second thing is that you should be happy if the seller exercises the option if there is still some time value left. When they do this, they are giving up on some time value. So if there is $100 time value left and the buyer exercises the option, he gives up that time value when he gets the futures. So either way, do not worry if you are protected.

If you only sell uncovered or naked options because you do not want to spend the money to buy options as protection, you might want to re think your strategy. Find cheap options to cover your sold options instead of being naked.

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Many traders who understand futures trading have a hard time understanding futures options. This is because the pricing of the options is sometimes different for the futures option contracts compared to the futures contracts.

For example, the 30 year t-bond futures contract has 32 ticks for each point in t-bonds. Each tick is worth $31.25. Now the options have 64 ticks in every point. Each tick in options is worth $15.625. See how this is confusing. Not every market is like this. The financials have markets like this as discussed with bonds and also the grains.

For instance wheat futures are priced at $50 per cent. Each tick is ¼ cent. So each tick in wheat futures is $12.50. In the options market there are 8 ticks in each cent. So each tick is 1/8 cent and each tick is $6.25. We buy and sell options while looking at the underlying contract. The underlying contract might be priced differently so that is why it can get confusing.

Keep this is mind when buying or selling any options and futures. You will notice the prices are different if you check the quotes in the futures market compared to the options market.

For bonds I might see that bonds are priced at 115-31. I then look at an option and it is priced at 1-32. Now you will notice that bonds are never priced above -31 because there are 32 ticks and the next tick after 31 ticks is one point. So after 115-31 the next price is 116. In bonds options as we have seen, the price of the option can go from 1-31 to 1-32 because there are 64 ticks in every point in the bond markets.

For wheat you can see futures at 5546 which is 554 and ¾ or 554.75. Three quarters happens to be the highest price for futures ticks. You might see an option contract for wheat priced at 9-7 which is 9 and 7/8 which is 9.875.

So remember this when you are comparing futures options prices with futures prices.

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There are many ways of trading in the futures commodity markets. One way is to trade futures options. There are many strategies you can use in trading futures options. You can just buy an option or just sell an option. You can also put on what is called a spread using options. Spread options are when you buy and/or sell more than one option at a time in the same order.

You can buy 2 options, sell 2 options or buy one option and sell another option. The options you buy have to be in a different strike price to be considered a spread. If you just were to purchase 2 of the same options, that would not be a spread. The 2 options would have to be 2 different future option contracts. Let’s look at corn. These are not current prices, just an example. If I purchased 2 $3.00 corn options, that would not be a spread. If I purchased one $3.00 corn option and sold one $3.10 corn option, that would be a spread. I would put this trade on in one order.

Not all spreads have to be in the same contract month or even the same market. When putting on a spread in different months, you could put in an order to buy one option in one month and sell another option in another month at a certain price. These are called calendar spreads as they involve different months.

Now when putting on a spread, you will either have money coming into your account or going out. If your purchased options cost more than the sold options, you would state that you are putting it on for a debit. If you are taking in more with the sold options than you are paying with the purchased options, you are putting the spread on for a credit. I will discuss other types of options strategy using spreads in another article.

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