While option trading is most commonly associated with stocks, commodity futures also have a robust derivative market. If you’re looking for additional methods to make money from corn, soybeans, and crude oil, keep reading. We’re going to give you some important tips on how to survive and prosper in the world of options on futures.
Similarities Between the Two Types of Options
Options on futures are very similar to options on equities. They both are divided into calls and puts. They both carry the right, but not the obligation, to buy or sell. They both carry expiration dates and strike prices. If you understand stock options, you’re off to a good start.
Equity Options v. Futures Options
You do need to be aware of some important differences. The biggest difference between stock options and commodity options is that the latter has much higher leverage. This results in a higher profit potential, but also more risk.
You have to post margin to write options on futures, but the amount can be small compared to the premium you will earn. In most cases, industry regulations require 100-150% of the premium to be set aside as margin. For example, say you sold a corn option for $400. You might need to deposit $500 in margin for this short position.
Another advantage that commodity options have over equity options is that the former usually can be sold for a nice premium much further out-of-the-money. In this situation, short-term price movements don’t have a significant effect on an option’s price.
A final benefit of going with futures options is that many of them have higher levels of liquidity than their equity cousins. Some commodities—such as gold, corn, and oil—can often be found with thousands of open contracts for each strike price.
Now that you understand some of the differences between the two, let’s look at an example. Suppose you’re bullish on the price of soybeans because it’s trading at $8.76 per bushel. This level is fairly low, so you decide to sell an OTM put with two months of life in it. You receive $1,700 for the sale, and this requires $2,100 in margin
The strike price is $8.70. As long as the price of soybeans stays above that level, the contract won’t be exercised; and the $1,700 profit will remain intact. Soybeans will only have to drop by 0.68% for the option to go in-the-money, though. Selling far out-of-the-money options could be a better trade.