Fundamentals of Commodity Option Trading

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”