Taking a right decision for an ideal broker commodity option trading depends on many factors in addition to your personal needs and specifications. There are broadly two types of broker commodity option trading – discount brokers and full service brokers.

Discount Brokers: Professional commodity traders, day traders, large institutional customers with high volume business, and seasoned expert traders in scalping and arbitraging always choose discount commodity brokers. Low commission is the fundamental reason for selecting a discount broker.

Full Service Broker: If you are a beginner and/or a serious investor looking to create a well balanced portfolio of commodity futures and options then it makes sense to go for full service commodity brokers. When you go for broker commodity option trading through a full service broker, the commissions are substantially high as compared to discount brokers. Nevertheless it is worth paying more commissions when you compare the hosts of features offered by full service brokers.

Moreover, the service standards of professionally managed commodity brokers and commodity firms are exceptionally good. You can expect professional quality commodity trading education, marker mover news updates, advanced trading strategies and research reports. Full service brokers may provide you a personal relationship manager to monitor your trades, portfolio and to send you alerts on potentially profitable investment.

Basic strategies:

Plain vanilla strategy is the alternate name for basic trades in online option trading. It involves buying call or put option (Long Call or Long Put) and selling call or put (Short Call or Short Put). When you trade long call or long put you can profit from the rise or fall in the price of the underlying assets. Long call or put can give you unlimited profit whereas the loss is limited to the amount of option premium paid by you.

Shorting a call or put (call/put writing) is a highly risky trade that can lead to huge losses. Here the profit is limited whereas the loss is unlimited. Call/Put writing is a skill that can be acquired only after thorough understanding of the intricacies involved in options trading. It takes years to develop the guts and skills required for call/put writing.

Remember that call option premium goes up if the price of the underlying commodity rises and vice-versa. Put option premium rises if the value of underlying commodity falls. There are many factors like time to expiry and implied volatility that can affect the proportion in which the premium value and the price of the underlying asset change with respect to each other.

Advanced strategies for online option trading:

In basic option strategies you take the position in naked call or put i.e. without any accompanying trades. Whereas in advanced strategies you take two or more positions in different expiry contracts in conjunctions with long, put, cash market and futures market. These strategies are best suited for hedging purposes and also for bulk trades (buying couples of contracts at a time). Covered call, spreads, straddles, strangles, butterfly – these are jargons of highly complicated advanced option trading strategies.

Summing Up
Learning the tricks of online options trading is a piece of cake if you are good at Math and Statistics. Most of the advanced strategies rely on option Greeks or option pricing models based on various mathematical and statistical fundamentals.

Contracts Specification

For commodity online option trading, you must understand the most important parameter known as contract specification or term sheet. Essentially speaking, any commodity options contract has four core components. Underlying commodity and its quantity, call or put, strike or exercise price and expiry date. Besides these four components, there are two more important features. Settlement terms of the contract and style of the option viz. American or European. Settlement terms can involve sash settlement or physical delivery or conversion to futures contract.

Option Pricing

Before you start commodity online option trading, you should have a fair idea about option pricing. Option price or premium is essentially derived from the futures contract which in turn tracks the cash or spot value of the underlying commodity.

In reality, the option pricing is a pretty complex task. There are many variables such as time component, implied volatility and option Greeks. Black Scholes model, stochastic calculus, and binomial pricing models are few Option pricing theories and models. Most of the commodity traders rely upon readily available calculators and analytical tools.

In the Money, At the Money and Out of Money Option:

In the money or at the money or out of money nature of option also plays a vital role in the option pricing.

When the strike price of the call option contract is less than the current market price of the underlying commodity futures then the call option is said to be in the money. Out of money call option signifies that the strike price is more than the current price.

In the money put option conveys that the strike price is more than current futures price. An out of the money put option indicates strike price is less than current futures price.

When the strike price and current price are equal then the call or put option is referred to as at the money option.

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”

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”.