Commodities Options Trading – Learn How To Trade In Bullish, Bearish And Neutral Markets
Most people are aware of the concept of insurance, which basically means the purchase of a small amount of premium for protection against a large uncertain loss in the future. In the agricultural industry, the losses in the past 10 years have been mostly due to changes in price levels that very few insurance companies are willing to provide insurance contracts. This is where commodities options trading come in as a form of insurance for the agricultural industry.
The theory behind the practice is relatively simple. On one hand, you have a commodity option where the products being sold are insured against price declines. On the other hand, you have another commodity option where the products being purchased are insured against price increases. Thus, the commodity options market is actually two separate options functioning in a complementary manner.
As one, the commodity options market is the venue where producers may purchase either the opportunity to sell or to buy a certain commodity at a certain price. You have to take note that the purchasers have the “opportunity” but never the “obligation” to actually exercise their end of the agreement. Thus, the term “commodities options trading” cannot be overemphasized in the general description of how the market works – options not obligations.
To make it clearer to the first-time entrants to the trading scene, let’s discuss an example. Mr. Smith desires to purchase the right to sell wheat at $300 a ton, which the commodity market will provide the opportunity. The premium will then be paid and the options can be collected if the prices are below $300 per ton when the wheat will be sold. However, if the prices are higher than $300 per ton, then the corn can be sold for its higher price while the cost of the premium will then be absorbed.
When you are already a veteran to the commodities options trading market, you will be able to appreciate the following basic strategies to trading in bullish, bearish and neutral markets:
- In bullish markets, it is best to buy a call when the option is undervalued and the price volatility is on the rise, which will keep losses limited to the premium paid. Selling a put is best during times of high volatility coupled with a bullish trending market, thus, keeping the profits limited to the premium received.
- In bearish markets, buy a put in case of undervalued options coupled with increasing volatility. Conversely, sell a call when the options are overvalued and the market is flat to bearish.
- In neutral markets, the best move is to strangle when volatility is peaking. Other moves include arbitrage or butterfly when credit is to be received at any time, calendar when small debit is involved, and guts when the options have attached time premium.
You may be bewildered by all of these terms used in commodities options trading. But don’t despair because you can always learn thee terms, apply them to real trading situations and make a neat profit from your risk capital. In the end, it is not luck that matters in trading but knowledge, wisdom and timing, all of which can be learned with time and effort.