Commodity option trading is an excellent risk management tool for different segments of industry participants. Besides the hedging of profit and loss, commodity option trading is widely recognized as an excellent tool for speculative profits.

Here’s a list of basic set of jargons used in commodity options.

Options: It is a contract to buy or sell an underlying asset at a certain price on or before a given future date. There are basically two types of options in commodity option trading. Call Options and Put Options.

Call Options: Call Options give the buyer the right but not the obligation to buy an underlying asset at a certain price on or before a given future date.

Put Options: Put Options give the buyer the right but not the obligation to sell an underlying asset at a certain price on or before a given future date.

Option Buyer or Holder: A person who buys the option is referred to as the option buyer or holder.

Option Seller or Writer: A person who sells the option is called as option seller or writer.

Option Premium or Price: For acquiring a right to buy or sell an asset, the option buyer has to pay a premium to the seller who receives it as his compensation for sacrificing his right. This premium is called as option Premium or price.

Underlying asset: It is an asset or a commodity such as gold, crude oil, forex.

Strike Price or Exercise Price: It is the price at which the transaction would take place when the contract is exercised.

Expiry Date: It is the last date on which the contract expires and it would be exercised.

American Option: Here the trader can exercise the contract on or before the expiry of the contract.

European Option: Here the contract can be exercised only on the expiry date.

Settlement of Options: Upon expiry the options contracts are settled either as cash settlement or by taking physical delivery or by taking positions in a futures contract.

In Conclusion:
Commodity option trading can add a new dimension to your investment portfolio provided you have thoroughly mastered the tricks of commodity option trading. Options terminology explained above is just a tip of the iceberg. It would not be wise to start commodity option trading without learning the advanced concepts in commodity options. Read tomorrow another article “Commodity Online Option Trading: Framework of Option Contracts”

Brief History
Although, option trading was known to the traders for couple of decades in the past but commodity options trading contracts were introduced by the recognized exchanges only during early 1990s. Over the last 20-30 years commodity options trading has gained tremendous popularity because of its distinct features and immense potential of generating high yield at lower costs and negligible margins.

Quintessence of Option explained
In financial lingo, an option is defined as a financial instrument that confers a right without obligation to execute a transaction on the underlying futures contract or a security or a physical asset.

A futures contract provides equal rights to both the parties whereas an options contract grants right to only one party – the buyer. If the contract tends to be favorable to the buyer then he can exercise his right to execution of the contract. On the contrary if the buyer feels that with the execution of the contract he would end up in a loss making proposition then the buyer can choose to back out or dishonor the deal or agreement. Buyer has the right but not the obligation to fulfill the contract.

Applications of Options
Options contracts are available on commodities like gold, metal, energy and agricultural products; financial products like currency future, interest rate; stocks and stocks indices and other class of assets like real estate. Commodity options trading have been universally accepted as an attractive class of asset as compared to other options contracts.

You can hedge the risks of existing position in a futures contract or cash or physical asset by commodity options trading. Options contracts also offer an excellent investment opportunity to a speculator or trader to profit from the fluctuations in option price.

Summing Up
Commodity options trading demand an in-depth knowledge of various facets of options. Tomorrow Carry on reading another article “Commodity Option Trading: Fundamentals of Commodity Options”.