Many investors recoil into a ball of fear and confusion when they hear the word commodities option.
However, there are ways of learning about this way of trading commodities to lessen your fear and clear up your confusion.
Failure is not an option when you have done your home work and taken the time to understand what options are all about.
It will help you to know some of the specialized terms involved with options trading.
An options contract is an agreement to purchase a volume of goods at an agreed upon price to be delivered at a date certain in the future.
The commodity which is the subject of the contract is called the underlying since it is the basis of the value for the contract and the value of this good will determine the value of the agreement - whether there is a profit or a loss.
The person selling the option is the seller and the purchaser is the buyer.
The price paid for the option is called the premium.
The rice at which the commodity is trading is called the market price, the cash price, or the spot price.
The price to be paid for the commodities is called the strike price.
The date of delivery or the date the contract comes to an end is called the expiration.
Now let's look at an example to see how this works.
Let's suppose that corn is selling at $5.
00 per bushel.
You must buy a minimum of 5,000 bushels.
You believe that corn is going to rise significantly over the next few months so you offer a strike price of $5.
50 per bushel for 10,000 bushels.
The seller is happy to enter into this contract and charges you a premium of $5,000.
00.
The contract is for three months in the future and its delivery price is $55,000.
00.
On the expiration date, corn is selling for $7.
00 per bushel.
You have made a profit of $1.
50 per bushel less expenses.
But what if corn is selling at $5.
00 per bushel on the date of expiration? You just walk away and suffer a $5,000.
00 loss.