How to Use Commodity Options to Trade the Futures Markets
Commodity options are an effective means of investing in the futures markets for all kinds of investors. Novice investors will find options attractive because they limit risk and allow you to gain exposure to the futures markets with a minimal upfront investment. For seasoned investors, options offer a great deal of versatility and allow for the implementation of many different trading strategies. Finally, options may be used as a hedge by anyone with a position in an underlying futures market.
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Instructions
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Identify a futures market that is poised to make a big move. Since all commodity options are based on a corresponding commodity futures market, you should have a good understanding of the underlying futures market before entering an options trade. Options allow you to capitalize off of a futures move with a comparatively small initial investment.
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Buy an option with a strike price near the current futures market price. An at-the-money or slightly out-of-the-money option will allow you to capture the most profits in the event of a big move in the futures market. Even if the price move is less than you initially expected, you may still make a profit on your option trade.
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Sell the option before expiration. While options do give you the right to enter the underlying futures market at the specified option strike price, it's generally better to simply sell your option back and take profits. Remember that options markets track futures markets, so it's not necessary to enter the underlying futures market when trading options.
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Sell your option back at a loss immediately if a trade moves against you and you are fairly certain that your option will expire worthless. While this situation is obviously less than ideal, you will at least recoup some losses rather than lose the entire premium you paid for the option.
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Tips & Warnings
While buying an option entails minimal risk, selling an option is a different matter. Novice traders should not sell uncovered options because this strategy often involves theoretically unlimited risk.
