An option remains valuable only if the stock price closes the option’s expiration period “in the money.” That means either above or below the strike price. (For call options, it’s above the strike; for put options, it’s below the strike.) You’ll want to buy an option with a strike price that reflects where you predict the stock will be during the option’s lifetime.
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However, for put options (right to sell), the opposite is true - with strike prices below the current share price being considered "out of the money" and vice versa. And, what's more important - any "out of the money" options (whether call or put options) are worthless at expiration (so you really want to have an "in the money" option when trading on the stock market).
The purchase of a call option is a long position, a bet that the underlying futures price will move higher. For example, if one expects corn futures to move higher, they might buy a corn call option. The purchase of a put option is a short position, a bet that the underlying futures price will move lower. For example, if one expects soybean futures to move lower, they might buy a soybean put option.
An option's price, its premium, tracks the price of its underlying futures contract which, in turn, tracks the price of the underlying cash. Therefore, the March T-bond option premium tracks the March T-bond futures price. The December S&P 500 index option follows the December S&P 500 index futures. The May soybean option tracks the May soybean futures contract. Because option prices track futures prices, speculators can use them to take advantage of price changes in the underlying commodity, and hedgers can protect their cash positions with them. Speculators can take outright positions in options. Options can also be used in hedging strategies with futures and cash positions.
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The world of commodity options is diverse and cannot be given justice in a short article such as this. The purpose of this writing is to simply introduce the topic of options on futures. Should you want to learn commodity options trading strategies in more detail, please consider purchasing "Commodity Options" published by FT Press at www.CommodityOptionstheBook.com.
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.
When you buy an option, the risk is limited to the premium that you pay. Selling an option is the equivalent of acting as the insurance company. When you sell an option, all you can earn is the premium that you initially receive. The potential for losses is unlimited. The best hedge for an option is another option on the same asset as options act similarly over time.
For strangles (long in this example), an investor will buy an "out of the money" call and an "out of the money" put simultaneously for the same expiry date for the same underlying asset. Investors who use this strategy are assuming the underlying asset (like a stock) will have a dramatic price movement but don't know in which direction. What makes a long strangle a somewhat safe trade is that the investor only needs the stock to move greater than the total premium paid, but it doesn't matter in which direction.
When buying a call option, the strike price of an option for a stock, for example, will be determined based on the current price of that stock. For example, if a share of a given stock (like Amazon (AMZN) ) is $1,748, any strike price (price of the call option) that is above that share price is considered to be "out of the money." Conversely, if the strike price is under the current share price of the stock, it's considered "in the money."