Option trading strategies

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An Introduction to Popular Commodity Option Trading Strategies

It is a false assumption to believe that an “option is an option”.  They may be spelled the same, but they are vastly different due to the nature of the underlying vehicles.  As a result options on commodities take on completely different characteristics.  After all, everybody agrees that trading stocks is poles apart from trading futures. Why would anybody believe that trading options on stocks is synonymous with trading options on futures? 

Years of witnessing the perils of a long option only strategy as a commodity broker led to my disappointment and pessimism in regards to a strictly option buying approach to the commodity markets.  Time decay and the tendency of markets to stay range bound work strongly against the odds of consistent profits with such a strategy. 

We can be reached at www.DeCarleyTrading.com. 

The Basics - How Options on Futures Work

There are two types of options, a call option and a put option. Understanding what each of these are and how they work will help you determine when to use them.  The buyer of an option pays a premium (payment) to the seller of an option for the right, not the obligation, to exercise.  This financial value is treated as an asset, although eroding, to the option buyer and a liability to the seller. 

Call Options – Give the buyer the right, but not the obligation, to buy the underlying at the stated strike price within a specific period of time.

·         Buyers face risk limited to the amount of premium paid plus transaction costs and unlimited profit potential

·         Sellers face unlimited risk beyond the strike price of the option and profit potential limited to the amount of premium collected minus transaction costs

Put Options – Give the buyer the right, but not the obligation, to sell the underlying at the stated strike price within a specific period of time.

·         Buyers face risk limited to the amount of premium paid plus transaction costs and unlimited profit potential

·         Sellers face unlimited risk beyond the strike price of the option and profit potential limited to the amount of premium collected minus transaction costs

Traders that are willing to accept considerable amounts of risk can write (or sell) options, collecting the premium and taking advantage of the well-known fact that more options expire worthless than not.  The premium collected by a seller is seen as a liability until it is either offset by buying it back, or it expires.  This is important, many beginning option sellers assume that because they receive the cash up front and they can see the amount of collected premium added to the ledger balance on their account statement, that it is somehow theirs.  Until the position is closed, the only thing that is certain is that there is risk on the table and the trade should be treated accordingly; this is the case regardless of the amount of money collected for the option or the amount of any open profit associated with the option.

   

  Call (Bullish) Put (Bearish)  
Buy     Limited Risk
Sell     Unlimited Risk

 

Source: http://www.carleygarnertrading.com/learn-to-trade-commodities/commodity-option-strategies/643-popular-commodity-option-trading-strategies




1. Buying a Call Option

A call option is the right to buy stock, or in this case an ETF.

Up until the expiration date of the call, you have the right to buy the underlying ETF at a certain price known as the strike price.

While the price of each call option will vary depending on the current price of the underlying ETF, you can protect or expose yourself to upside buy purchasing a call. To break even on the long call trade, you just have to hope the ETF rises above the strike price and the purchase price of the call you bought. So if you buy the Dec 80 call for , you need the ETF to climb above to break even.

Anything over is profit. If the ETF never gets above , your loss is for every call you bought.

2. Selling a Call Option

When you sell a call, you take the opposite position of a call buyer. You want the ETF to go down. Using our example, if you sell the Dec 80 call for , you will make on every call if the ETF price never rises above .

However, if the ETF does climb above the break-even point of , you are liable to sell the ETF at to the call owner and incur the loss.

Selling options is a more advanced trading strategy than buying options. When purchasing options, the maximum risk is the purchase price and the profit is unlimited to the upside. However when selling an option, the maximum profit is the sale price and the risk is unlimited. An investor should be very careful and very educated before selling options.

3. Buying a Put Option

There is a safer way to gain exposure or hedge the downside of an ETF than selling a call option. If you think an ETF will decline in value or if you want to protect downside risk, buying a put option may be the way to go. A put option is the right to sell an ETF at a certain price. Using our example, if you buy the Dec 80 put, you will have the right to sell the underlying ETF for at any time before December. If the ETF trades at anytime before December, you can sell it at and profit on the difference in price.

Source: https://www.thebalance.com/four-basic-etf-option-trading-strategies-1214890



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