There are two types of commodity options, a call option and a put option. Understanding what each of these is and how they work will help you determine when and how to use them. The buyer of a commodity option pays a premium (payment) to the seller of the option for the right, not the obligation, to take delivery of the underlying commodity futures contract (exercise). This financial value is treated as an asset, although eroding, to the option buyer and a liability to the seller.
• Put Options – Give the buyer the right, but not the obligation, to sell the underlying at the stated strike price within a specific period of time. The seller of a put option is obligated to deliver a short position from the strike price (accept a long futures position) in the case that the buyer chooses to exercise the option. Keep in mind that delivering a short futures contract simply means being long from the strike price.
Pay a “premium” wherever you buy a commodity option. Let's say you purchase a “call” option on 100 bushels of corn, and the premium is $2 per bushel. You will pay $200 for the right to exercise your option until it expires. That is your only cost to purchase the option, except for whatever commission you had to pay to your brokerage company. Even if you choose not to exercise the option before it expires, your investment will be limited to the $200 premium plus commission.
If you are buying an option that is already "in the money" (meaning the option will immediately be in profit), its premium will have an extra cost because you can sell it immediately for a profit. On the other hand, if you have an option that is "at the money," the option is equal to the current stock price. And, as you may have guessed, an option that is "out of the money" is one that won't have additional value because it is currently not in profit.
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The information contained in this article is provided for general informational purposes, and should not be construed as investment advice, tax advice, a solicitation or offer, or a recommendation to buy or sell any security. Ally Invest does not provide tax advice and does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances.
For example, a plastics producer could use commodity futures to lock in a price for buying natural gas by-products needed for production at a date in the future. The price of natural gas—like all petroleum products—can fluctuate considerably, and since the producer requires the natural gas by-product for production, they are at risk of cost increases in the future.
Time Value: All options contracts have an expiration date, after which they become worthless. The more time that an option has before its expiration date, the more time there is available for the option to come into profit, so its premium will have additional time value. The less time that an option has until its expiration date, the less time there is available for the option to come into profit, so its premium will have either lower additional time value or no additional time value.
Of course, many investors, especially new investors, are skittish about options. After all, no investor is required to trade this way, and the transactions can seem complicated. But once you know the pros and cons of this type of investing, it can be a powerful part of your strategy. No investors should be sitting on the sidelines simply because they don’t understand options.
Options markets trade options contracts, with the smallest trading unit being one contract. Options contracts specify the trading parameters of the market, such as the type of option, the expiration or exercise date, the tick size, and the tick value. For example, the contract specifications for the ZG (Gold 100 Troy Ounce) options market are as follows:
Purchasing a call option is essentially betting that the price of the share of security (like a stock or index) will go up over the course of a predetermined amount of time. For instance, if you buy a call option for Alphabet (GOOG) at, say, $1,500 and are feeling bullish about the stock, you are predicting that the share price for Alphabet will increase.