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Selling or Writing Commodity Futures Options
Selling futures options is a little known strategy to new commodity traders, but it is widely used among professional futures traders. Selling commodity options and writing commodity options have the same meaning. In order for a futures option contract to be created, a commodity trader must buy a futures option and another futures trader must sell (or write) a commodity option. Just as in commodity futures contracts, a futures trader can initiate a futures option trade by buying or selling an option contract. When you sell a futures option that you don’t already own, you are granting the buyer of the commodity option the right to buy (for call options) or sell (for put options) a futures contract at the given strike price of the futures option any time before the futures option expires. In return for giving the futures option buyer the right to purchase the futures option, the futures option seller will receive a premium for selling the commodity option to the futures option buyer. This concept is very similar to how the gaming industry works. The house takes the bet and the wager is the amount paid for the opportunity to make money. Therefore, the house is considered the futures option seller and the person placing the bet would be the commodity option buyer.
A simple example of selling a futures option
You sell a July $6.00 soybean call at 20 cents or $1000 = (.20 x 5,000 bushels).
The futures option buyer pays you the $1000 premium for the $6.00 soybean option call you sold the option trader. This money is put into your commodity trading account. In order to secure the position, the commodity futures exchange will require you to put up commodity margin money in excess of the money you received from the futures buyer. The amount of commodity margin money required will vary, but it will not be higher than the margin requirements for a commodity futures contract for soybeans. Normally, the further the soybean futures option is out of the money, the less commodity margin that is required.
There are several things you can do to manage the short commodity option position you have in your commodity trading account.
You can close out (liquidate) the soybean call option at any time (during commodity market trading hours) by placing an order to buy back the soybean call option. You can have a profit or loss on the soybean call option you sold, depending on the original sell price and your buy back price.
You can hold the soybean call option until it expires. If the soybean call option expires out of the money, you will have made a profit and get to keep the whole premium you originally collected and nothing further needs to be done. The soybean call option will have no value if it is out of the money on the date of expiration and simply disappears worthless.
If you decide to hold the soybean call option until expiration and the futures option is in the money, the soybean call option buyer will likely convert it to a soybean futures contract at the option strike price. Therefore, the commodity futures exchange will put a soybean futures contract in your account (long if it is a put and short if it is a call). The soybean option then disappears and you have to liquidate the soybean futures contract that has been placed in your trading account, in order to close out the soybean futures trade. You will retain the option premium you originally collected on selling the soybean call option, and you may have a profit or loss depending on where the soybean futures contract is trading when you liquidate the soybean commodity futures contract.