When trading commodities there are 2 basic ways to trade: futures or options. Depending on the portfolio size, the risk tolerance and ultimate goals we will suggest assorted strategies to take advantage of the same anticipated move in an underlying commodity. That may mean an individual speculating on gold moving higher if they foresee inflation, a farmer buying put options in agriculture as a hedge or perhaps a combination of futures and options depending on the exact plan. Trading futures ultimately means one is trading on margin which some are not comfortable, with while trading options may offer an alternative without the sleepless nights.
When purchasing options, one's risk is limited to the premium paid plus any fees for the transaction. When writing or granting options the risk becomes greater, and without going into intricate details, it may be useful to be more familiar with the terms below when trading commodity options. Find below an explanation of the "option Greeks." It is important for an active options trader to at least become familiar with these characteristics since he/she may need to make quick decisions about trading strategies and risk management on the fly.
Delta
Delta is the amount by which the option changes compared to the underlying commodity. It is a measure of the probability that an option will expire in-the-money. Call deltas can be interpreted as the probability that the option will finish in-the-money. Put deltas can be interpreted as -1 times the probability that the option will finish in-the-money. An at-the-money option, which has a delta of approximately 0.5, has roughly a 50/50 chance of ending up "in-the-money". For example, if an at-the-money sugar call option has a delta of 0.5, and if sugar makes a 100 tick move higher, the premium on the option will increase approximately by 50 ticks (0.5 x 100 = 50), or $560 (each tick in premium is worth $11.20).
An explanation of delta values is below:
Call options: 0 to 1 Put options: -1 to 0
In the money options: Delta approaches 1 (call: +1, put: -1)
At the money options: Delta is about 0.5 (call: +0.5, put: -0.5)
Deep out of the money options: Delta approaches 0
Long calls have a positive delta: You want the market to go up
Short calls have a negative delta: You want the market to go down
Long puts have a negative delta: You want the market to go down
Short puts have a positive delta: You want the market to go up
Gamma
Gamma, measures the rate of change of delta. When call options are deep out-of-the-money, they generally have a small delta. This is because changes in the underlying commodity bring about only minute changes in the price of the option.
