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Oil Futures Options and Their Possibilities

The existence of unique financial instruments known as oil futures options allow many investors to turn this precious resource into an investment that brings a return without all of the risk normally found in the futures market. The distinction between futures and options are at the heart of this opportunity.

Oil futures options differ from regular oil futures primarily because of the clause in the options contract which gives the holder the right but not the obligation, to buy a certain quantity of oil at a set time in the future. This provides the buyer of an option some insurance against unforeseen activity in the market which sends prices suddenly up or down. In any case, the buyer can only lose what he or she initially invested, an amount known as the premium, with an option. With a future, the losses are potentially much greater. Also, options holders never have to worry about a margin call. However, these advantages are no longer available once the market closes on the expiration date of the contract.

Such options are divided into two categories. These categories are known as call options and put options. Bullish traders, who think that oil prices are going to rise, will buy call options. These allow the trader to buy a commodity such as oil at a fixed price which they hope will be lower than the actual value of the commodity at some point in the duration of the contract. Put options allow the trader to sell the contracts at a fixed price, even if the market value of the oil has dropped below that price.

Oil Futures Options Vs. Regular Oil Futures

These options are not without risk, or they would not be so lucrative. They offer the ability to limit loss and give the buyer some additional leverage. However, they can also expire as worthless and lose the buyer's entire investment.

In addition to this leverage and limitation against losses, oil futures options also offer a lot of flexibility in your investment. They are wisely used in combination with regular futures to minimize loss and maximize gain. They also provide an excellent sense of insurance during times of high volatility.

However, these options also suffer from time decay. The value of an options contract lessens as time passes. Since you can choose to switch from buying options to selling options, this risk is somewhat lessened.

Oil futures options are traded on the New York Mercantile Exchange (NYMEX) and one option contract covers 1,000 barrels of oil and their prices are quoted in dollars and cents per barrel. Since one barrel of oil is 42 gallons, one option contract covers 42,000 gallons of oil.

Oil futures and their options are quoted on the exchange as:1. NYMEX Light Sweet Crude2. NYMEX Brent Crude

Once you understand the relationship between oil futures and their associated options contracts, you can employ option trading strategies that either focus exclusively on only options contracts, OR on a combination of holding futures contracts (in which you can take either a "buy" or "sell" position) and options for same commodity, in this case, oil.

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