Futures Options Trading » commodity option trading

Commodity Options Trading: Volatility Matters

pwohlstand — Mon, 01 Sep 2008 03:16:26 +0000

It’s amazing how many people who are just entering into the realm of commodity options trading don’t seem to keep in mind the basic factor that makes options do what they do, and that’s volatility. If you understand the effect that volatility has on the options market, you will understand how sometimes extraordinary profits can be pulled from trading commodity options with very little relative investment. When you trade options, you are basically trading volatility, nothing more, nothing less. There’s no such thing as a “stable” option. Remember the option is only going to be as stable as the futures contract that the option represents. If there’s a whirlwind of speculation going on in the futures contracts (a la crude oil), you can guarantee automatically that option writers are padding their premiums to compensate for any potential moves that the market might make against them. Simply put, volatility is the measure of “nervousness” that’s in the markets, based on a sense of uncertainty as far as what the futures prices might do, or where those prices might go. Volatility is basically reflected in the sharp rises and drops in option premiums, and the degree of fluctuation that those premiums experience. If you use it right, volatility can be your best friend. Once you understand a little about market psychology, you can truly exploit volatility to create some serious profits in a relatively short period of time. That’s one thing that I emphasize to people when I talk about commodity option trading, is the fact that you have to be ready to “strike while the iron is hot”. Unfortunately, options trading is not something you can do as a “set and forget” type of investment; it requires your active involvement. Reason being is because there are opportunities that crop up in the options markets all the time, but if you hesitate, or fail to recognize the opportunity when it’s staring you in the face, you will definitely miss out on the whole enchilada.

Before I get sidetracked, let me mention the fact that there are two types of volatility in commodity options trading (and really all options trading for that matter): Historical and implied. Historical volatility is basically the “track record” of a given futures market’s price swings. In other words, how stable (or unstable) have market prices been throughout history? There are all kinds of charting tools to measure historical volatility, and it’s good to study them to get a “feel” for how a market’s prices will have regular peaks and valleys, especially more seasonal-based commodities like the grains (corn, wheat, soybeans, etc.) and for the most part the softs (coffee, sugar, cocoa, etc.). Implied volatility is the kicker-it’s basically the market’s guess at how stable (or unstable) prices will be in the future. The basic reason why it is important to understand volatility is because it will tell you what your best plan of action is, as far as what type of position to take in the markets. If you expect volatility to increase, it’s NOT a good idea to write options. Conversely, if you expect volatility to decrease, buying options will prove to be a disappointment, because time decay will “do its dirty work” on the option’s premium, and you’ll see your profits (if any) eroding away right with it. So, to put it in a positive light, if you believe that volatility will increase, it’s better to buy options, and if you believe that volatility will decrease, it’s better to sell (or write) options.

Well, I have to sign off for now; I’m actually about 20,000 feet in the air, making my descent into Atlanta. I just thought that I would take the time to post some more thoughts about commodity options trading while I was in flight…it’s amazing how (and when) inspiration will hit.

What Does Commodity Option Trading Mean to Me?

pwohlstand — Sat, 02 Aug 2008 21:54:17 +0000

Here I’ve written some thoughts on commodity option trading, and what it means to me…I want to develop in the art of being a good trader; this means more than just making a bunch of money. I want to truly develop discipline and skill as a trader, and to constantly challenge myself to become a better trader. I believe that making a ton of money will naturally follow when you develop into being a good trader. Good trader=root; Tons of $$$=Fruit. I truly believe in the ”base hits” theory; enough base hits will eventually equal the home run. In other words, steady, consistent profit-taking when trading commodity options is more in line with sound trading principles (in my mind) than waiting on (and betting on) a “home run”. This helps me to avoid falling into the “jackpot mentality”, where you’re trying to play the markets like you would play the lottery. Any time a person approaches commodity options trading with a gambling, “fast-buck” mentality, they’ll see profits running in the opposite direction. Those who attempt to make a killing in the markets end up getting killed. I fully believe in being aware of (and respectful of) the power of leverage at all times. Leverage truly is a two-edged sword. You must treat it with respect, and never be presumptuous or arrogant about the markets, as if you can always predict their movements. I believe in maintaining the attitude of flexiblility, where even my most informed decisions about how I’m going to enter or exit a trade, could be wrong based on the market’s movements. I believe in using the widsom that God gave me to keep me from making a trading decision that would be thoroughly disatrous. I don’t think there’s any shame in (or even anything wrong with) taking a loss. I believe that taking a loss in trading commodity options can actually be part of a winning strategy. It’s stupid to commit to a trading idea once you realize you’re going the wrong direction. It’s like the guy who gets “pot committed” in poker; it’s hard for him to walk away because he has put so much money in already…so he continues betting (and bluffing) until the entire fantasy comes crashing down on him, when the final hand is played. No need to do any of that drama; you just have to be smart in commodity option trading, and know your risk levels, as well as know when to say “uncle” and throw in the towel. Live to trade commodity options another day.

Commodity Option Trading–An Overview

pwohlstand — Sat, 02 Aug 2008 03:57:06 +0000

Hello everyone out there…One of my main “lanes of operation” has been commodity option trading; it’s what I know, it’s what I’m used to talking about, it’s what I’ve done throughout the past 7 years. I’ll be the first to admit that the world of commodity option trading is a hairy, complicated beast–it takes years to learn what drives the options markets, and in particular, the different factors that come into play when determining an option’s premium. So much should be taken into account–volatility, price action, the general market sentiment (bullish or bearish), time, and a host of other things that would take a mathematician to explain. The cool thing about it is that once you understand the basics of trading commodity options, it becomes a “lather, rinse, repeat” process across all the different markets. Each market has its own personality, and the option premium behavior within each market also has a personality of its own. You just have to be in the markets to truly get a feel for it, and that takes time…nothing more, nothing less. I can say that I have definitely graduated from the commodity options school of hard knocks, and I know what it takes to make money in the commodity options market, and I also know what it takes to lose money as well. I’ve done quite a bit of both over the past 7 years, and although I am FAR from “guru status”, and don’t claim to be a guru about commodity option trading, at the same time I’ve learned how to boil all the principles down to something workable for pretty much anyone that has a willingess to learn some very basic commodity option trading strategies.

My intention with this site is not to turn it into some boring, dry clinic on commodity options trading, but rather to share some of my personal experiences in trading commodity options. I will include many journal entries from my personal trading notebook, in hopes that some valuable lessons can be gleaned from my successes and failures. Plus, it is somewhat cathartic to get this all out and publish it on a website. Go figure. At the end of the day, this site will be about my personal experiences in commodity option trading, and if you so desire, please join me for the ride.