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Commodity Trading Resources |
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Futures Options Trading
Buying Futures Options - Calls and Puts
Most people undoubtedly start trading Futures Options or Commodity Options by buyin Puts or Calls. That is
the simplest way to trade and your risk is defined - you can't lose more than you invest. Unfortunately,
the time erosion of these options can eat you alive if you are not careful. You have to know the timeframe
of your trade and buy the proper month and strike price of Futures Options. There's nothing worse than expecting
the market to move up while you are long calls and the market stays flat. Then, you options expire worthless (100% loss)
and the market rallies the next week. Professional Futures Option Traders are aware of time decay of Commodity Options
and realize they are theoretically losing money each day on their options.
Futures Options Volatility Premiums
The more the particular Commodity Market is panicked due to drought, politcs, etc. the more volatility
premiums are added to the price of these Futures Options. For example, if the Corn crop was planted a bit late
due to weather problems and the weather forecasts for Iowa and the Midwest are calling for a a heat wave over the next two weeks
of 100 degree temps. the Corn market would probably rally quickly. Commodity Traders would quickly buy Corn Futures
and Corn Futures Options, thus bidding the price higher and adding to volatility. Since there is a more likely chance
for a huge rally, those Selling Futures Options will demand a higher premium. Far out of the money options
will be bid to outrageous premiums, because Traders believe they can get more leverage buying far out of the
money options since there price is lower. In reality, it is a longshot prices will ever reach the "panic" prices
people will be discussing. The moral of the story is - Be cautious chasing markets by buying far out of the money
Futures Options.
How about Selling / Writing Futures Options
Some good work has recently been published by James Cordier and Michael Gross of Liberty Trading Group.
They manage money for high net worth clients and their specialty is Selling Futures and Commodity Options.
Their recent book The Complete Guide to Option Selling(McGraw-Hill 2005) outline many of the Futures
Options Strategies they implement and the best setups for trades.
The basic theory is that selling Futures Options puts the odds in your favor. There is theoretically more
risk since you can lose more than your investment, unlike buying options. This scares many investors who seek the
safety of only losing your premium as the worse case scenario. However, the statistics show that most options expire worthless
and the odds of making a postive return selling Futures Options is greater. An analogy of selling options is that
of being a bookie. People place the bets with you (you write the futures options and they pay you the money) and if the bet
doesn't payoff (options expire worthless) you keep the money. How many bookies go broker compared to how many gamblers
going broker? Consider yourself Vegas or the House. If you manage you money properly, you should continue
to win in the long run, since the odds are in your favor.
More in-depth articles to follow. Check back regularly.
Disclaimer: TRADING IN COMMODITY FUTURES OR OPTIONS INVOLVES SUBSTANTIAL RISK OF LOSS. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
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