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Commodities Options Trading

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Understanding Commodities Options Trading

Commodities Options TradingCommodities Options Trading is a powerful trading tool that can be utilized to diversify trading opportunities out of stocks and into commodities.  A commodity can include a wide variety of raw materials such as silver or natural gas or agricultural products such as corn or soybeans, among many others that have a similar quality and are mass produced.  A commodity is a fungible item; meaning it can be replaced or exchanged by another identical product of similar quality that is produced anywhere.  The fungibility of commodities is what makes trading them possible, since interested parties can buy and sell the right to purchase a commodity knowing that they will be buying a product that is of similar quality no matter where it is produced.

Commodities are traded on a commodities exchange.  The leading commodities exchanges in the United States are:  Chicago Board of Trade (CBOT), Chicago Mercantile Exchange (CME), and New York Mercantile Exchange (NYMEX).

Commodities trade via contracts between buyers and sellers.  A commodities contract can consist of:  spot commodity prices, commodity forwards, commodity futures, and options on commodity futures.  Commodities options trading utilizes options that are based on the price of a commodity futures contract for a given commodity.  The mechanics and strategies associated with commodities options trading are the same as those utilized for stock options trading.  The reason why traders should consider commodities options trading is because it opens up new opportunities for options traders to make profits beyond the stock market.  Like stocks, commodities fluctuate in price and sometime make sharp price moves, which commodities options traders can take advantage of to make money.

Commodities Options Trading Strategies

Commodity options can be used to speculate on anticipated price moves in commodities.  A trader buys a commodity call option to profit from an anticipated move higher in the price a commodity.  The higher the move above the target price (strike price) the commodity call option makes before the expiration date, the higher the profit is for the buyer of the commodity call option.  Conversely, to speculate on anticipated price move lower in a commodity, a trader buys a commodity put option.   If the commodity futures contract falls below the strike price before the expiration date, the commodity put option can be sold for a profit (after the expense of buying the option is accounted for).

Since commodities options trading carries the risk of losing all of the trading capital committed to trading commodity options, there are a number of options trading strategies that can employed to greatly reduce the risk to commodity options trading capital.  See Managing Options Trading Risk for more details on options trading strategies.  To learn more about futures, see Buying and Selling Futures.  To learn more about options on commodity futures, see Option Trading Basics.

Those who wish to trade commodities options are encouraged to learn as much as possible about commodity options trading, which can be a very useful trading tool to take advantage of price moves in commodities.

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