Definition of Future options/ Commodity options
Here are the details of commodity options/ future options or options market in an easy to understand with an example.
Commodities investment refers to investment in commodities. The definition of commodity can be defined as a good which can exchange with some similar good or commodity. Commodity options is a kind of trading in which producer or holder of a commodity can enter into a contract to buy or sell a certain quantity of commodity at a certain price (called as "Strike Price") after the expiry of a predetermined time period. The commodity can either be a metal like gold, lead, zinc, etc. or an agricultural product like wheat, grains, etc. In simple words, we can say that it provides an opportunity to the buyer to buy or sell the product at a certain price on a certain time. However, he has no compulsion or obligation to do so.
Terminology in commodity options
Commodity options are also termed as 'Option market' or 'Future options'. Other terms used in commodity market are as follow:
- Buyer of commodity: Option holder
- Seller of options: Options Writer
- Price at which commodity can be bought or sold: Strike price, Exercise price
- Price at which option can be sold: Option premium, Option price
- Date of expiry of options contract: expiration dateTypes of future options
It is mainly of two types:
- PUT option: Option holder can sell pre determined amount of the commodity at a certain price at a certain price He has a right to do so without any obligation.
- CALL option: Option holder can buy pre determined amount of the commodity at a certain price from the buyer at a certain price. He has a right to do so without any obligation.
Let's take an example to understand the concept of future options in a better way. A farmer trades into options market at the time of sowing seeds. He enters into an agreement that he will sell 1000 bags of rice at the rate of Rs. 700 per bag. But at the time of harvesting, he realizes that the price of rice has been decreased to Rs. 500 per bag. But he needs to worry as he had already traded into future options. Thus he can earn profits by selling his bags of rice at an increased price of Rs. 700/ bag. On the contrary, if the price of rice increases to Rs. 900, then he can earn returns by selling his commodity at such increased price since he has a right to trade in options market but no obligation.