The potential home buyer would benefit from the option of buying or not. Imagine they can buy a call option from the developer to buy the home at say $400,000 at any point in the next three years. Well, they can—you know it as a non-refundable deposit. Naturally, the developer wouldn’t grant such an option for free. The potential home buyer needs to contribute a down-payment to lock in that right.
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.
Fluctuations in option prices can be explained by intrinsic value and extrinsic value, which is also known as time value. An option's premium is the combination of its intrinsic value and time value. Intrinsic value is the in-the-money amount of an options contract, which, for a call option, is the amount above the strike price that the stock is trading. Time value represents the added value an investor has to pay for an option above the intrinsic value. This is the extrinsic value or time value. So, the price of the option in our example can be thought of as the following:
• 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.
Similarly, if you believe the company’s share price is going to dip to $80, you’d buy a put option (giving you the right to sell shares) with a strike price above $80 (ideally a strike price no lower than $80 plus the cost of the option, so that the option remains profitable at $80). If the stock drops below the strike price, your option is in the money.
The Problem arises if one party fails to perform. The trader may fail to sell if the prices of steel goes very high like for example INR 40,000 in January 2017, in that case, he may not be able to sell at INR 31,000. On the other hand, if the buyer goes bankrupt or if the price of steel in January 2017 goes down to INR 20,000 there is an incentive to default. In other words, whichever way the price moves, both the buyer and seller have an incentive to default.
Futures options can be a low-risk way to approach the futures markets. Many new traders start by trading futures options instead of straight futures contracts. There is less risk and volatility when buying options compared with futures contracts. Many professional traders only trade options. Before you can trade futures options, it is important to understand the basics.
Decide whether you think a commodity will sell for more or for less at some designated time in the future, then buy either a “put” or a “call” option. For example, you think that corn will cost more three months from now than it does now, so you will buy a “call” option on 100 bushels of corn which, in effect, locks in the cost of that commodity. Before the option expires, hopefully the price will go up, so your option will be worth more. Conversely, you will buy a “put” option if you think the price of the commodity will be less than it is today.
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.
If a company locks in the price and the price increases, the manufacturer would have a profit on the commodity hedge. The profit from the hedge would offset the increased cost of purchasing the product. Also, the company could take delivery of the product or offset the futures contract pocketing the profit from the net difference between the purchase price and the sale price of the futures contracts.
However, unless soybeans were priced at $15 per bushel in the market on the expiration date, the farmer had either gotten paid more than the prevailing market price or missed out on higher prices. If soybeans were priced at $13 per bushel at expiry, the farmer's $15 hedge would be $2 per bushel higher than the market price for a gain of $2,000,000. On the other hand, if soybeans were trading at $17 per bushel at expiry, the $15 selling price from the contract means the farmer would have missed out on an additional $2 per bushel profit.
Conversely, a put option is a contract that gives the investor the right to sell a certain amount of shares (again, typically 100 per contract) of a certain security or commodity at a specified price over a certain amount of time. Just like call options, a put option allows the trader the right (but not obligation) to sell a security by the contract's expiration date.