Posted on 21 July 2012.
There are several different options on futures; it is important to understand what they are and how they work before entering into the commodities arena. The seller of a commodity sells the put option to the buyer; this price is often determined by the strike price, duration, and actual commodity. The people who purchase put options are those who believe the commodity is going to go down during the period of the contract; this is a way to hedge risk in an investment for what amounts to a small fee.
The futures market is much like the stock market; investments are made on heavy speculation with other investments used to hedge the risk. Put and call options are investments with a built in version of hedging. If the initial investment goes sour, the only thing the investor loses is the original cost to purchase the call or put option. Those who are willing to sell the options feel that the commodities are going to head in the other direction and they will be able to profit through the fees to purchase the option. Put options can be a powerful tool when an investor wants to hold onto a stock, but is afraid that it may plummet suddenly.
Buying a put option is a very good idea, because it gives the buyer a low level of risk, but allows for unlimited potential; it is like paying a small fee to buy insurance against a stock plummeting. Call options are a similar situation, but in reverse; the option buyer is getting insurance against a stock that skyrockets. Savvy investors will look for great options on futures that can add profit to their portfolio without tying up all of their available funds.
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