Futures Options Trading | What It Takes to Trade Commodity Options

What It Takes to Trade Commodity Options

by Phil R.

In the realm of commodity options trading, you have to be prepared to face the uncertainties and volatility that the futures markets can throw at you. Make no mistake about it, when you enter into the arena of futures options trading, you are truly throwing down the gauntlet for the “ultimate challenge”. You have to keep in mind that options is simply a game of educated guesses. It’s always based more on what everyone thinks the market is going to do, instead of what it is actually doing. It is vital for you to make that distinction before even beginning to enter a trade. The options markets are inherently speculative. The whole drama of it is the big question mark about what the markets may or may not do. This is where you get volatility skews and parity in puts and calls. This is why option writers pad their premiums the farther out in months the options go, because they realize that the farther the timeline extends, the more probability there is for uncontrollable events to affect market prices. It has always been the sign of “options noobs” to buy cheap out-of-the-money calls that have a large amount of time left, only to see their option values decay as time passes, while the market simply doesn’t “shake up” enough to affect premiums to their advantage in any way. A lot of people fall victim to the misconception that 80% of options expire worthless, and while that sure seems like it’s true, it’s not–80% of options are never exercised, mostly because they are later offset. The reason why I mentioned this here is because if you plan on buying a cheap out-of-the-money call with a ton of time left, be prepared to see a dramatic drop in the value of your option as time passes, unless the underlying market does some major moving & shaking during your “holding period”. When this major drop in value happens, if you are wise, you will exit by offsetting your position instead of allowing your option to expire worthless. This is an integral part of money management, which is probably the number one requirement for a person to successfully engage in commodity options trading; you have to conserve your trading capital and not try to be some super-hero, willing to hock your house on a lucky chance. Know when you’ve been beat…I repeat, you gotta know when you’re getting your butt kicked in the markets, and exit gracefully, even if you take a hit in your trading capital. It’s better to be prudent than to struggle with trying to “be right” and “teach the markets a thing or two”…the only thing that will happen is that they’ll teach YOU a thing or two, and have you pay tuition for the lessons.

So it becomes very important in futures options trading to pay attention to what’s going on with the underlying futures contract, because the option’s movements are always going to be based on this, no matter how strange they may behave sometimes. And again, always keep in mind that option writers are not dummies; they’re like insurance underwriters…they’ve done their homework, they know the percentages and probabilities of profits or losses for each strike price, and for the most part, they adjust their premium prices accordingly. Occasionally, they will get blown out by sudden market spikes or sell-offs, but at the end of the day, it is an art to recognize a truly undervalued option, and then be able to properly capitalize on trading it. In this blog we will go into various commodity options trading strategies, and learn how to recognize these opportunities in the markets when they present themselves. I can’t promise some majorly structured lessons, like a curriculum or anything, but I will share some of my successful trades (and some of my duds), and you can hopefully see these trades in action. One thing is for sure; with every trade, no matter if you come out with a profit or exit with a loss, you learn something. You pick something up. You have another tidbit of information to add to your trading repertoire, and you’ll always be better prepared for the next trade than you were for the last one. This, my friend, is some of what it takes to cut the mustard in trading commodity options.

Filed Under Commodity Options Trading, Trading Principles, Trading Psychology | 2 Comments

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Comments

2 Responses to “What It Takes to Trade Commodity Options”

  1. Tim Ramsey on August 15th, 2008 4:26 am

    I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog.

    Tim Ramsey

  2. P.R. on February 26th, 2009 7:13 pm

    Good article…I’m still an “options noob”, so this information is quite helpful.