Commodity Options
The commodity options market is a market where producers can purchase the
opportunity to buy or sell a commodity at a specific price. These are
generally agricultural products like wheat and soybeams, or natural resources
like oil, copper or gold. Like the farmer who is able to collect on an
insurance policy if his barn burns down, he can also purchase the right to
sell his commodities at a specific price. One commodity option can insure
products being sold against price declines, while another can insure products
purchased against price decreases.
The underlying asset in the commodity option isn't the commodity itself, but
rather a future contract for the commodity. For example, a December wheat
option will actually be an option for a December delivery wheat futures
contract. The options are on the futures and not the actual commodity.
There are three steps to evaluating option prices. First is selecting the
appropriate option contract month. Choose the option that will expire closest
to, but not before, the time the commodity will be sold or bought. If wheat
will be harvested and sold in November, the January option would be
appropriate.
Second, decide the type of option to buy. If wishing to insure products
against a price decline, then purchase a put. If wishing to insure purchases
against price increases, buy a call option.
Finally, calculate the minimum selling price offered by the put option, or
the maximum purchase price for the call option. Doing so can help you insure
yourself regardless of the situation.
One group that handles commodity transactions is the Chicago Board of Trade.
The CME offers a wide variety of commodity options, with futures on grains,
livestock, oilseeds, dairy, lumber and more.
Types of Exchange Traded Options
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