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 example: A trader in October 2016 agrees to deliver 10 tons of steel for INR 30,000 per ton in January 2017 which is currently trading at INR 29,000 per ton. In this case, trade is assured because he got a buyer at an acceptable price and a buyer because knowing the cost of steel in advance reduces uncertainty in planning. In this case, if the actual price in January 2017 is INR 35,000 per ton, the buyer would be benefitted by INR 5,000 (INR 35000-INR 30,000). On the other hand, if the price of steel becomes INR 26,000 per ton then the trader would be benefitted by INR 4,000 (INR 30,000- INR 26000)
Puts are more or less the mirror image of calls. The put buyer expects the price to go down. Therefore, he pays a premium in the hope that the futures price will drop. If it does, he has two choices: (1) He can close out his long put position at a profit since it will be more valuable; or (2) he can exercise and obtain a profitable short position in the futures contract since the strike price will be higher than the prevailing futures price.
Sometimes corporations enter the forex market in order to hedge their profits. A US company with extensive operations in Mexico, for example, may enter into a futures contracts on US dollars. So, when it comes time to bring those Mexican profits home, the profits earned in pesos will not be subject to unexpected currency fluctuations. The futures contract is a way of securing an exchange rate and eliminating the risk that peso will lose value versus the dollar, making those profits worth less in dollars.
In search of a promising commodity option trade, it is important to look at whether or not the options are priced fairly. Option prices fluctuate according to supply and demand in the underlying commodity market. At times, options on futures prices become inflated or undervalued relative to theoretical models such as Black and Scholes. For example, during the "crash" of 2008 the value of put options exploded as traders scrambled to buy insurance for their stock portfolios or simply wanted to wager that the equity market would go down forever. The increase in option premium was partly due to inflated volatility but increased demand for the instruments had a lot to do with it. Those that chose to purchase put options at inopportune times and at overvalued prices, likely didn't fair very well.
According to Nasdaq's options trading tips, options are often more resilient to changes (and downturns) in market prices, can help increase income on current and future investments, can often get you better deals on a variety of equities and, perhaps most importantly, can help you capitalize on that equity rising or dropping over time without having to invest in it directly.
Strike Price: This is the price at which you could buy or sell the underlying futures contract. The strike price is the insurance price. Think of it this way: The difference between a current market price and the strike price is similar to the deductible in other forms of insurance. As an example, a December $3.50 corn call allows you to buy a December futures contract at $3.50 anytime before the option expires. Most traders do not convert options to futures positions; they close the option position before expiration.
The price at which you agree to buy the underlying security via the option is called the "strike price," and the fee you pay for buying that option contract is called the "premium." When determining the strike price, you are betting that the asset (typically a stock) will go up or down in price. The price you are paying for that bet is the premium, which is a percentage of the value of that asset.