What You Need to Know to Trade Commodity Options

Breaking down commodity options

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    Trading options can be a complicated process. Information overload among the uninitiated is prevalent, as a lot of options strategies are available and traders need to evaluate all of the possible routes ahead of executing a trade. As such, Schaeffer's is  starting a new educational series titled Optimizing Your Options Strategies. The beauty of options trading is that there are options strategies for every market environment. In this series, we will cover all available options strategies for an educated trader to consider when identifying trading opportunities.

    One of the most popular options strategies with arguably the best name in the investing world is utilizing commodity options. Commodity options do not differ significantly from equity options. Ultimately, both of options are derivatives allowing traders the right to buy or sell the underlying. In commodity options, the options give a trader the choice to buy or sell the commodity in question, whereas equity options give a trader the choice to buy or sell the stock (or equity) in question. Remember, options do not obligate one to buy or sell the underlying. Rather, traders have the liberty to exercise options any time before the option expiration date.

    Traders can choose from a wide array of commodities when trading in commodity options. The underlying commodity can be anything from copper or oil to wood or soybeans, or any other raw materials. Much like an equity options trader, the commodity options trader draws up an options contract that must include the following information:

    • Details of the underlying commodity.
    • The expiration date.
    • Details of the premium and the strike price.

    The specifics of a commodity options contract are extremely important to understand. It is highly recommended that a trader pay extra attention to the details surround the commodity options contract.

    Commodity call options and commodity put options logistically work in the same way that equity call options and equity put options do. The only difference is the underlying asset. With equity options, the underlying Is an equity like a stock or ETF. With commodity options, the underlying is a commodity like metals, oil, and corn. A commodity call option involves buying an option on the commodity at a defined strike price and a defined expiration date with a bullish orientation. On the other hand, buying an option on the commodity at a defined strike price and a defined expiration date with a bearish orientation. In both types of commodity options, the option seller will collect a premium from the option buyer.

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