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Trading Futures Options
There are many profitable day trading strategies that can be applied to trading commodities. Markets move up and down and speculators on the evolving prices of commodity futures use both fundamental and technical analysis in order to gain a profit. A means of limiting risk and leveraging capital when trading commodities is trading futures options. A trader can buy puts or calls on a commodity futures contract just as he or she can buy puts or calls on a stock. In trading futures or trading futures options one is not buying or selling the commodity. Both futures contracts and options contracts are derivative instruments. In this the base equity could be crude oil. A trader can engage in oil futures trading or trading futures options on crude oil. The same applies to live cattle, winter wheat, gold bullion, and many other tradable commodity futures.
The Commodity Futures Market
The commodity futures market is used by two groups of traders. The first group includes companies and individuals that buy and sell commodities such as gold bullion, crude oil, or soybeans. These folks buy and sell futures or engage in trading futures options to hedge business risk. Let’s say that an agricultural cooperative sells winter wheat produced by its members. The price of winter wheat may fluctuate greatly as there is a drought in North Dakota and heavy rains in the Ukraine, both major wheat growing areas. If these conditions continue wheat prices will be very high by the time that harvest comes. But, if the weather improves in one or both areas the price of wheat may fall dramatically. Obviously the cooperative would prefer to be paid well for the coming harvest. One way to insure this is to sell futures on winter wheat. The price is currently high (in this hypothetical example). In selling futures on wheat the cooperative is obligating itself to sell at the current price. However, what if the weather in North Dakota and the Ukraine gets worse and there are hailstorms in Kansas further decreasing the total harvest? By trading futures options the cooperative retains the right to sell at the contract price if the market price falls. It also preserves the right to not execute the option and not sell at the contract price if, in fact, the market price climbs higher. By not ever entering a futures contract but rather buying options, the trader does not need to tie up money in a margin account for the futures contract.
The other group of traders is composed of speculators. They pick and choose which commodities they wish to trade and engage in trading futures options on a wide range of commodities, depending on where there is market volatility and the chance for a profit. These traders may use tools such as trend following in day trading or scalping in day trading in order to gain incremental profits as the market moves up and down.