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How To Trade Commodity Options for Profitable Trades

Trading commodity options can be highly profitable. It can be more profitable than stock options because it brings risk management to an entirely new level and gives plenty of flexibility. Compared to index or stock options, strategies for trading commodity options can be exchanged with lesser margin. These options can also be used for both speculative and income purposes. Moreover, the margin rules of SPAN allow usage of less capital for trading commodity options. Today commodity options trading is substantial for complicated options strategies with the help of brokers who use deep discount commissions, online trading platforms, electronic trading platforms, and electronic mini contracts.

Commodity options are just like stock options when it comes to trading transaction. The only difference between the two is the multiples of option premiums that each represents. Apparently, there are different advantages gained from commodity options that include low margins & high yields, lower commissions, low slippage, better hedging, no additional margin trades, call credit spread, and additional trades.

Most of the trading in commodity options use the SPAN margin rules where the calculation is centered on all angles of a selection. This can be very advantageous to traders. For instance, a trade that uses collar strategy will have lower margin compared to the same trade that uses indices or stocks directly. Lower margins will result in better utilization of capital as well as higher profits.

With trading commodity options, the slippage per deal per trade is huge. However, in most cases, a trade option that involves the same currency size will result in low slippage. The slippage is even less with commodity options that are electronically traded like e-mini contracts and gold options. Most of the strategies with trading commodity options needs few adjustments or hedging during the span of a trade. The general rule for hedging or adjustment is going short or long of the principal to watch over if the principal is not in favor of the trade. E-mini contracts and futures provide the best method to hedge or adjust with low capital requirements.

Trading commodity options don't have extra margin trades. With careful assessment of current trades, possible extra trade opportunities may arise. These additional opportunities can decrease the overall margin the trade requires.

Apart from the above advantages of trading commodity options, the trader must be aware that trading options as well as futures involve considerable risks of loss or gain that can be unsuitable for all traders. Below is a list of tips that you can use for profitable options trading:

The substantial advantages of spread strategies include the following:

  1. The likelihood of a profit is over 90% as opposed to over 90% losses when options and futures are "played long."

  2. You "make out like a bookie" in that you use plenty of other peoples' money -- amplitude that sweetens the pot.

  3. Other peoples' money cushions and shields your own investment capital when markets, portions of markets and individual stocks and futures contracts become tempest-tossed. Bob McGovern wrote in CTCN (2/95): "I don't have to figure how much my short October is making or losing, or calculate how much the long April contract is making or losing. All I have to check is the difference in price between the two contracts." Thus the spread strategist can be seen relaxing while financial cyclones wreck other traders' money and nerves.

  4. There are at least two ways to profit, one of them termed "time-decay." Being closer to the expiration date, what you sold (short-end) shrinks faster in value than what you bought. Your investment is in the gap between them, what McGovern called "the difference in price between the two contracts." The widening of that gap means your vein of gold becomes broader.

With time-decay, you use "the ravages of time" as a force to swell bank accounts.

The second way to gain is a switch to the long position. Let us say that an underlying stock or futures contract rises to the "striking price" level of your horizontal call option spread or descends to the level of your put spread. You buy back the short-end and let the long-end remain. According to trend theory, that underlying security has "broken through a barrier" and will probably continue in that direction. Such a continuation increases the long position's dollar-value.

Some spread strategists wait until the underlying security passes through the striking price and into the money before they buy back the short-end. I close out the short-end when the security "touches" the striking-price even though it is not yet "in the money." The continuation failed to occur only once and succeeded more times than I can count. Delaying the buy-back would have meant more cost and therefore less profit because the continuation -- Bless it! -- swells the short-end while beefing up and fattening the long.

Remember that American-style options can be exercised at any time, unlike the just-before-expiration European ones. Buy back, close out any in-the-money short positions fast! Also, when following trends, remember a statement by Nicholas Darvas: "There is no such thing as "can't" in the stock market. A stock can do anything!"

Due to space limitations, this article contains only bits and pieces of information on spread strategy. This form of trading offers plentiful profits with amazingly low risk, and the use of other people's money while they take the big risks. But read and learn you must, and in no small depth. Technical analysis or chart analysis fits in well with spread strategies -- the horizontal calls above the rising security, the horizontal puts below the falling one.