Commodity options are similar to derivative contracts. It is bit different compared to non-convertible debentures. NCDs or Non convertible debentures are a financial tool that is realised by companies to raise long-term funds through public issue.
Features of Commodity Options Trading
Commodity options are sometimes compared to insurance. When you buy an insurance for your home, you pay a premium to activate your insurance policy and realise certain rights that start from the day your policy is active. These rights are limited because the policy depending on circumstances can limit the payoff. To some extent, this seems to work same as hedge fund, but similarity ends here, it consolidates on speculation. For example, an option buyer during stock trade phase, has unlimited profit potential. Though it should be noted that this profit is theoretical. Insurance policies on the contrary have a stated limit. Unlike options, Insurance is not transferable between parties. The policy shows that it belongs to a particular individual or specific to certain property.
Commodity options are standardised, open to public and can be easily sold in the marketplace. Exchange-traded options are easy to understand so quite simple to trade in the market.
Types of Options
There are two types—the call option and the put option. The features are comprehensibly straightforward, and they can be used effectively under certain conditions by both market speculators and stock hedgers. The price of an option is called the premium, the meaning and feature is altogether different to the insurance premium. The premium is actually a one-time cost incurred by the trader and represents the exposure that the cost can buy.
It does not matter how high the price rises or how low it dips reflecting market fluctuations, the option buyer due to initial premium knows exactly his exposure to maximum risk. Though there is limit to the risk, the potential margin to earn profit is not fixed. As with commodity trading, potential profits from option are limited as it is depended on how high the market moves in specific period of time, minus the initial cost incurred.
Options are available for almost all types of futures market; grains, fruits, natural gas, gold, copper, heating oil, currencies., etc. Feature of each futures stock product is based on liquidation of the position. The most liquid, active and transacted futures markets have generally the most liquid option markets. As per current situation, crude oil leads the futures market as the most liquid commodity contracts market followed by corn and then natural gas.
Price structure depends on the type of product. Let us take example of crude oil or natural gas. The spot price does not show the actual problems the sector faces. on the contrary, many times the pricing structure is quite misleading to all of us. This pushes a sense of urgency of investments to be made in the development of new oil rigs.
Judging by these levers of futures, the pricing conclusion is evident: one day oil rig plants will face a natural shortage, you don’t have to an expert to know when this will happen. This will prove fatal for the industry. Stock prices will keep dwindling with some minor corrections. It can be stopped when new oil fields are found and rigging again gains momentum.
Irrespective of issues the commodity sectors usually faces, the spot price of oil in this for example. is determined by the coming month’s futures contract with the most volume shared.