Futures and Commodity Options

A futures option contract will expire in a certain amount of days. Basically, a commodity option contract is a bet that a market will move in a certain direction within a certain amount of time. When a commodity trader buys an option on a futures contract, the futures trader has to be correct on the direction of the particular commodity market, as well, as the timing of the move. Otherwise, the futures option will expire worthless and the commodity trader loses his entire investment.

For example, if a commodity trader buys a futures option contract that has an option value of $600.00 and the futures contract has 60 days until expiration, the commodity option theoretically will lose $10 every day if the futures market remains unchanged. The rate of time decay actually increases at an increasing rate, as the expiration date gets closer. Many commodity traders will not buy out of the money futures options with a few days left until expiration, because of the high probability that the futures option will expire worthless.

Buying futures options appeals to many commodity investors since there is limited risk. However, that does comes with a price. The price is in the form of a wasting/depreciating asset. When trading futures options, the commodity option trader is looking for a quick move or is expecting a long-term trade.  The reason for this is because of the depreciation of the commodity option with time.  The more time you have on an option, the more expensive it will be. Therefore, you need to understand your objective before you buy an option contract.

When trading futures options, it is important to understand ones trading timeframe and realize that commodity options are a wasting asset. The commodity trader should buy a futures option with enough time to meet their trading objectives. Otherwise, the futures trader may be right on market direction, but wrong on the timing.  A big winner ends up being a loser.  This is simply devastating to futures option traders.