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How to Trade Futures Options

How to Trade Futures Options When The Deals are all so Diverse

Learning how to trade futures options is a little more complex than learning stock options. The main reason for this is that, in addition to the normal things you need to know about stock options, with commodities you have to add the varying relationships between the underlying commodities, their respective futures contracts and the number of units that an options contract on the futures contract, covers.

For example, stock options are a simple matter of "one options contract covers 100 shares" - or whatever number it is depending on which national stock market you're into. Then you simply add the usual elements associated with options such as implied volatility, time decay, intrinsic or extrinsic value, expiration dates etc. etc.

But how to trade futures options includes another step - how the underlying commodity is measured in units and how many units are covered by one options contract. They're all different.

So let's have a look at the different types of commodity futures options that can be traded, where they are traded, the units they are traded in and how many of those units are covered by an options contract.

How to Trade Futures Options - Energy Sector [Traded on NYMEX]

Energy is one of the favorite commodities traded.

Energy commodities include:

  • Crude oil - is the oil directly from the underground and has to be refined before it can be used. The futures are traded in barrels and each barrel equals 42 gallons. One option contract on crude oil futures covers 1,000 barrels of oil.
  • Heating oil - is also known as the No.2 oil. People use heat oil in their houses to keep them warm. Also traded in barrels with one option contract covering 1,000 barrels.
  • Natural gas - is a hydrocarbon gas, basically composed of methane, propane, butane, ethane etc., used for heating house and cooking. Futures are traded in British Thermal Units (BTUs) and one options contract covers 10,000 BTU's.
  • Gasoline - is a mixture of refined petroleum hydrocarbons. Gasoline is commonly used as fuel. It is traded in gallons and one options contract covers 21,000 gallons.

How to Trade Futures Options - Grains [Traded on CBOT]

Grains basically consist of fruits, seeds and grasses. They are actively traded during the spring and summer.

The most common types of grains include:

  • Corn - majority of corns are used to produce animal feed. The rest would be consumed by human and turned into industrial products eg. corn oil, starch, ethanol etc. Corn futures are traded in bushels and one options contract covers 5,000 bushels.
  • Wheat - has very wide range of use. Besides human consumption, it is mainly used to produce flour. The residues would go to animal feed. Wheat futures are traded in bushels and one options contract covers 5,000 bushels.
  • Oats - is popularly used as livestock feed. It could be turned into oatmeal for human consumption. Oats futures are traded in bushels and one options contract covers 5,000 bushels.
  • Rice - is the primary food for the world. It is traded in the form of rough rice. Rice futures are traded in hundredweight (cwt) units and one options contract covers 2,000 cwt.
  • Soybean - is used as livestock feed and feed for fish farming. Soybean can also be produced into soybean oil. Now soybean has become one of the important sources to produce biodiesel. Soybean futures are traded in bushels and one options contract covers 5,000 bushels.
  • Soybean Meal - futures are traded in tons and one options contract covers 100 tons.
  • Other grains commodities traded include barley and canola.

How to Trade Futures Options - Softs [Traded on ICE]

Softs comprises of commodities which are grown. They are also known as the group of food and fiber.

The most usual traded softs include:

  • Cotton - majority of cottons are used for textiles and home furnishings. China is the largest producer of cottons. Cotton futures are traded in pounds and one options contract covers 50,000 pounds.
  • Sugar - is mainly refined from sugarcane. Sugar is one of the mostly subsidized items around the world. The largest producers are Brazil, India and China. Sugar futures are traded in pounds and one options contract covers 112,000 pounds.
  • Orange juice - is traded in the form of frozen concentrated orange juice or in short FCOJ. Brazil is the largest producer of FCOJ and fresh orange. Orange juice futures are traded in pounds and one options contracts covers 15,000 pounds.
  • Cocoa - the primary use of cocoas are to make chocolates. Chocolates are mainly consumed by the European countries. The largest cocoa producers are Ivory Coast, Ghana and Indonesia. Cocoa futures are traded in metric tonnes and one options contract covers 10 metric tonnes.
  • Coffee - is traded in the form of coffee beans. Coffee is the most popular drink in the world. The largest coffee producers are Brazil, Vietnam and Colombia. Coffee futures are traded in pounds and one options contract covers 37,500 pounds.
  • Other softs commodities traded include milk, butter and lumber.

How to Trade Futures Options - Metals [Traded on NYMEX]

Metals are mainly raw inputs used in electronic and manufacturing industries. Precious metals are usually related to jewelry products.

Common metals traded include:

  • Gold - is the most precious commodity. Gold is mainly used to make jewelry and coins. Gold futures are traded in ounces and one options contract covers 100 troy ounces.
  • Silver - is also categorized as precious metal. Silver is used mainly used in photography, jewelry and electrical appliances production. Silver futures are traded in ounces and one options contract covers 5,000 troy ounces.
  • Copper - is a good electrical and heat conductor. Therefore, copper has been popular used to make electrical wiring. Copper futures are traded in pounds and one options contract covers 25,000 pounds.
  • Other metal futures traded with options include Palladium, Platinum and Uranium.

How to Trade Futures Options - Livestock [Traded on CME]

The commonly traded livestock are pork bellies, live cattle and lean hogs

  • Pork bellies - are usually used for making bacons. You may not find a close substitute to bacon made with pork bellies. Futures are traded in pounds and one options contract covers 40,000 pounds.
  • Live cattle - refers to cattle which have grown to a stage where they are ready to be slaughtered. Live Cattle futures are traded in pounds and one options contract covers 40,000 pounds.
  • Lean hogs - refers to pigs which have grown to a stage where they are ready to be slaughtered. Lean Hogs futures are traded in pounds and one options contract covers 40,000 pounds.

The above are only a few examples of how to trade futures options on different commodities - and you'll notice it's quite evident that the varying relationships between the options and the number of units of measure they control means varying degrees of leverage.

This extra dimension in options trading must be understood if you're serious about how to trade futures options.

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