In our opinion, commodity markets coming off of long-term highs or lows typically present traders with an extraordinary prospect. However, it is important to realize that just because a commodity seems "cheap" doesn't mean that it can't go lower. Likewise, while we would never advocate buying (or being bullish with options) a commodity at an all time high, it is always possible that prices can continue higher but generally speaking options in such an environment are over-priced. As a result, they come with magnificently low odds of success.
• Call Options – Give the buyer the right, but not the obligation, to buy the underlying at the stated strike price within a specific period of time. Conversely, the seller of a call option is obligated to deliver a long position in the underlying futures contract from the strike price should the buyer opt to exercise the option. Essentially, this means that the seller would be forced to take a short position in the market upon expiration.
Options on futures contracts are exactly what the name implies, they give traders "options". They are capable of being used in nearly every commodity market scenario and with variable risk and reward profiles. Too many traders fail to tap the true potential and flexibility of option spreads due to their seemingly complex nature; however, things aren't always as they appear. We strongly believe that you owe it to yourself to overcome your fear of trading commodity options and open your mind to the possibilities.
In the case of perishable commodity, the cost of storage is higher than expected future price of a commodity (For ex: TradeINR prefer to sell tomatoes now rather than waiting for 3 more months to get a good price as a cost of storage of tomato is more than price they yield by storing the same). So in this case, the spot prices reflect current supply and demand, not future movements. There spot prices for perishables are more volatile.
In Economics, a commodity is a marketable item produced to satisfy wants or needs. The commodity is generally Fungible (Fungibility is the property of a good or commodity whose individual units are capable of being substituted in place of one another). For example, since one ounce of pure gold is equivalent to any other ounce of pure gold, gold is fungible. Other fungible goods are Crude oil, steel, iron ore, currencies, precious metals, alloy and non-alloy metals.
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Based on data from IHS Markit for SEC Rule 605 eligible orders executed at Fidelity between April 1, 2018 and March 31, 20198. The comparison is based on an analysis of price statistics that include all SEC Rule 605 eligible market and marketable limit orders of 100-499 shares for the 100 share figure and 100–1,999 shares for the 1,000 share figure. For both the Fidelity and Industry savings per order figures used in the example, the figures are calculated by taking the average savings per share for the eligible trades within the respective order size range and multiplying each by either 100 or 1000, for consistency purposes. Fidelity's average retail order size for SEC Rule 605 eligible orders (100 -1,999 shares) and (100–9,999 shares) during this time period was 430 and 842 shares, respectively. The average retail order size for the Industry for the same shares ranges and time period was 228 and 333 shares, respectively. Price improvement examples are based on averages and any price improvement amounts related to your trades will depend on the particulars of your specific trade.
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.
There are also exotic options, which are exotic because there might be a variation on the payoff profiles from the plain vanilla options. Or they can become totally different products all together with "optionality" embedded in them. For example, binary options have a simple payoff structure that is determined if the payoff event happens regardless of the degree. Other types of exotic options include knock-out, knock-in, barrier options, lookback options, Asian options, and Bermudan options. Again, exotic options are typically for professional derivatives traders.
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.
Options on futures began trading in 1983. Today, puts and calls on agricultural, metal, and financial (foreign currency, interest-rate and stock index) futures are traded by open outcry in designated pits. These options pits are usually located near those where the underlying futures trade. Many of the features that apply to stock options apply to futures options.
Call writers and put writers (sellers), however, are obligated to buy or sell if the option expires in-the-money (more on that below). This means that a seller may be required to make good on a promise to buy or sell. It also implies that option sellers have exposure to more, and in some cases, unlimited, risks. This means writers can lose much more than the price of the options premium.
Volatility: If an options market is highly volatile (i.e. if its daily price range is large), the premium will be higher, because the option has the potential to make more profit for the buyer. Conversely, if an options market is not volatile (i.e. if its daily price range is small), the premium will be lower. An options market's volatility is calculated using its long-term price range, its recent price range, and its expected price range before its expiration date, using various volatility pricing models.
Many day traders who trade futures, also trade options, either on the same markets or on different markets. Options are similar to futures, in that they are often based upon the same underlying instruments, and have similar contract specifications, but options are traded quite differently. Options are available on futures markets, on stock indexes, and on individual stocks, and can be traded on their own using various strategies, or they can be combined with futures contracts or stocks and used as a form of trade insurance.
Just as there are several ways to skin a cat, there are an unlimited number of option trading strategies available in the futures markets. The method that you choose should be based on your personality, risk capital and risk aversion. Plainly, if you don't have an aggressive personality and a high tolerance for pain, you probably shouldn't be employing a futures and options trading strategy that involves elevated risks. Doing so will often results in panic liquidation of trades at inopportune times as well as other unsound emotional decisions.
If in six months the market crashes by 20% (500 points on the index), he or she has made 250 points by being able to sell the index at $2250 when it is trading at $2000—a combined loss of just 10%. In fact, even if the market drops to zero, the loss would only be 10% if this put option is held. Again, purchasing the option will carry a cost (the premium), and if the market doesn’t drop during that period, the maximum loss on the option is just the premium spent.
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:
In case of futures, a buyer of a contract is said to be “long position holder” and a seller is “Short position holder”. In the case of futures, to avoid the risk of defaulting contract involves both parties lodging a certain percentage margin of value of contract with a mutually trusted third party. Generally, in gold futures trading, margin varies between 2%-20% depending on the volatility of gold in spot market.
Arbitrage arguments: When the commodity has plentiful supply then the prices can be very well dictated or influenced by Arbitrage arguments. Arbitrage is basically buying in one market and simultaneously selling in another, profiting from a temporary difference. This is considered riskless profit for the investor/trader. For example, if the price of gold in delhi is INR 30,000 per 10 grams and in Mumbai gold price is INR 35,000 then arbitrageur will purchase gold in Delhi and sell in Mumbai
Traders that are willing to accept considerable amounts of risk with the prospects of limited reward, can write (or sell) options, collecting the premium and taking advantage of the well-known belief that more options than not expire worthless. The premium collected by a commodity option seller is seen as a liability until the option is either offset (by buying it back), or it expires. This is because as long as the option position is open (the trader is short the commodity option), there is substantial risk exposure. Should the futures price trade beyond the strike price of the option, the risk is similar to holding a commodity futures contract outright.