logo
  Join        Login             Stock Quote

Commodity Risk Depends Upon Trading Strategy

 August 08, 2007 10:53 PM


 

Many believe that commodity trading is risky and rightly so. This is reinforced even by the disclosures required by federal regulators that emphasize the inherent risk of commodity trading and its corresponding unsuitability for many members of the investment community. However, the degree of risk of a commodity trade depends upon the type of strategy being used. Several types of strategies can be used to participate in a market move and each has different degrees of risk. They are listed below from low risk to progressively higher risk. (The list is not exhaustive: some of the more complicated strategies have been left out.) These strategies are all directional trading strategies meaning that they are used to capitalize on a movement up or down of the market's price.

[Related -Seven Top Stocks With Fresh Dividend Growth Or Share Buybacks]

Option Spread Purchase............... Risk Rating: 1

This a low-risk strategy. If prices are expected to rise, then the trader can buy a bull call option spread. If prices are expected to decline, then the trader can buy a bear put option spread. Option spreads can be a little difficult to understand initially and to execute, but the trader can (hopefully) rely on their broker for support in this area.

Outright Option Purchase............... Risk Rating: 1.5

An outright option purchase is still a low-risk strategy, but because the initial cost and hence, maximum loss, is larger than that for a corresponding option spread, it is a little more risky. This is an easier strategy to employ, though. If prices are expected to rise, then the trader buys a call option and if prices are expected to decline, the trader buys a put option.

[Related -The Chip Maker Short Sellers Should Be Watching]

Futures with Protective Option............... Risk Rating: 2.5

This strategy is moderately risky. If prices are expected to rise, then the trader can buy a futures and simultaneously buy a protective put option. If prices are expected to decline, then the trader can sell a futures and simultaneously buy a protective call option. Because option prices tend to move less than corresponding futures prices, the trader may want to rely on their broker's assistance in formulating this strategy.

Covered-Write............... Risk Rating: 3

This strategy is slightly more risky than the previous ones. If prices are expected to rise, then the trader can buy a futures and simultaneously sell an out of the money call option. If prices are expected to decline, then the trader can sell a futures and simultaneously sell an out of the money put option. Protection in an adverse scenario is not as effective as in the above strategies. Again, the trader may want to rely on their broker's assistance in formulating this strategy.

Futures with Excess Margin............... Risk Rating: 4

This strategy relies on an outright purchase of a futures (with a protective stop) if prices are expected to rise, and an outright sale of a futures (with a protective stop) if prices are expected to decline. With every futures contract, the trader maintains higher margin in the account than what is required. For instance, if the maintenance margin on a contract is $1,500, then the trader may trade as if the margin were twice or three times that amount. This has the effect of reducing the leverage and lowering the volume of trading, both of which lower risk.

Futures with No Excess Margin............... Risk Rating: 5

This strategy is identical to the above strategy with the exception that no excess margin is maintained in the account. All of the trader's risk capital is being used to meet margin requirements on futures positions (each of which has a protective stop order). This is the riskiest trading strategy (apart from reckless trading such as trading without a stop order or day trading to avoid margin requirements altogether). The futures trader should know each of these strategies and focus on those which are consistent with their overall tolerance towards risk.



How to Read an Account Statement Is Day Trading Less Risky?
iOnTheMarket Premium
Advertisement

Advertisement


(1)
 
10/10/2009 12:46:24 PM
raghu by raghavendra
i want some information
Rating: (1) (0)

Comments Closed


rss feed

Latest Stories

article imageThe Chip Maker Short Sellers Should Be Watching

Investing in semiconductor stocks is always tricky. Industry cycles can lead to bumps in the road for the read on...

article imageChicago Fed: US Economic Growth Slowed In October

The pace of US growth slowed more than expected in October, according to this morning’s update of the read on...

article imageHoliday Fever Takes Hold Of Stock Investors, But A Pullback Is Needed

With warmer weather arriving to melt the early snowfall across much of the country, investors seem to be read on...

article imageIs 0% Growth For 90% A Successful Economic Model?

Via Greg Mankiw I read the review of Piketty's book by Deirdre McCloskey. The review reminds me of the read on...

Advertisement
Popular Articles

Advertisement
Daily Sector Scan
Partner Center



Fundamental data is provided by Zacks Investment Research, and Commentary, news and Press Releases provided by YellowBrix and Quotemedia.
All information provided "as is" for informational purposes only, not intended for trading purposes or advice. iStockAnalyst.com is not an investment adviser and does not provide, endorse or review any information or data contained herein.
The blog articles are opinions by respective blogger. By using this site you are agreeing to terms and conditions posted on respective bloggers' website.
The postings/comments on the site may or may not be from reliable sources. Neither iStockAnalyst nor any of its independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. You are solely responsible for the investment decisions made by you and the consequences resulting therefrom. By accessing the iStockAnalyst.com site, you agree not to redistribute the information found therein.
The sector scan is based on 15-30 minutes delayed data. The Pattern scan is based on EOD data.