Advanced Volatility Trading & Delta Neutral Strategies

A commodity option is a two-party agreement giving the buyer (or holder) the right, but not the obligation, to take a designated futures position. This potential position can be either a short or a long position in the designated futures contract (called the underlying futures contract).

The futures position will also be provided at a specified price (called the strike price), and the right exists until a pre-established date (the expiration date). You purchase the option from the option seller (or writer). The writer of an option has the obligation (not the right) to provide the option holder with the futures position at the agreed upon strike price. As the buyer, you purchase the option at the going market price (called the premium).

If cash prices move unfavorably, you may use the option to obtain the protection associated with a futures position. Remember, the option seller is obligated to provide you with the futures position at the strike price. However, you do not want the protection associated with a futures position if cash prices move favorably. As the holder of the option, you choose whether or not to take the futures position. Thus, options are similar to purchasing insurance.

You pay the premium, but may or may not need and/or use the protection associated with the right to a futures position. Two types of options are available for each underlying futures contract. The purchase of a put option gives the holder the right to a short futures position (sell a futures contract) at the strike price. The writer (or seller) of the put is obligated to provide the holder with the short futures position.

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