5 Surprising Advantages of Selling Commodities Options Over Stock Options
“The price of a commodity will never go to zero. When you invest in commodities futures, you’re not buying a piece of paper that says you own an intangible piece of company that can go bankrupt.” – Jim Rogers
About 80% of the new clients I speak with have some type of experience with stock options. Most of them, when prodded, express a desire to “get properly diversified” as one of their chief reasons for taking the next step to commodities. What intrigues me is that few have a firm grasp of the real advantages that commodities options can offer – especially if they are accustomed to the constraints that stock option selling can place on an investor.
Don’t get me wrong – selling equity options can be a lucrative strategy in the right hands. However, if you are one of the tens of thousands of investors that sells equity options to enhance your stock portfolio performance, you may be surprised to discover the horsepower you can get by harnessing this same strategy in the commodities arena
WATCH OPTIONSELLERS.COM’s James Cordier Explaining Why Commodities Over Stock Options?
In this day and age, diversification is more important than ever. But the advantages don’t end there.
5 Key Differences between Stock and Futures Options
Selling (also known as writing) options can offer benefits to investors in equities or commodities. However, there are substantial differences between writing stock options and writing futures options. What it generally boils down to is leverage. Futures options offer more leverage and therefore can offer greater risk, but also greater potential rewards. But this same leverage opens up several other key advantages you may have never heard of. If you’ve only ever sold equity options, this seminar
In selling equity options, one does not have to guess short term market direction to profit. The same remains true in futures, with a few key differences.
1. Lower Margins (Higher ROI):
A key factor that attracts many stock option traders to futures. Margins posted to hold short stock options can be 10 to 20 times the premium collected for the option. With the SPAN margin system used in futures, options can be sold with out of pocket margin requirements* for as little as 1 to 1 ½ times premium collected. For instance, you might sell an option for $600 and post a margin of only $700. (Total margin requirement minus premium collected). What does this mean for you? The potential for a large return on your invested capital. (Of course, corresponding risk applies to this as well.)
2. Big Premiums: Attractive premiums can be collected for Deep out of the money strikes.
Unlike equities, where to collect any worthwhile premium, options must be sold 1-3 strike prices out of the money, futures options can often be sold at strike prices far out of the money. At such distant levels, short term market moves will typically not have a big impact on your option’s value. Therefore, time value erosion may be allowed to work less impeded by short term volatility.
Many equity option traders complain of poor liquidity hampering their efforts to enter or liquidate positions. While some futures contracts have higher open interest than others, most of the major contracts like Financials, Sugar, Grains, Gold, Natural Gas, Crude Oil, have substantial volume and open interest offering several thousand open contracts per strike price.
4. Real Diversification
In the current state of financial markets, many high net worth investors are seeking precious diversification away from equities. By expanding into commodities options, you not only gain an investment that is 100% uncorrolated to equities, your option positions can also be uncorrelated to each other. In stocks, most of the time, your individual stock (option) will be largely at the mercy of the index as a whole. If Microsoft is falling, chances are, your Exxon and Coca Cola are falling too. In commodities, the price of Natural Gas has little to do with the price of Wheat or Silver. This can be a major benefit in diluting risk.
5. Fundamental Bias
When selling a stock option, the price of that stock is dependent on many, many factors – not the least of which is corporate earnings, comments by CEO/Board, legal actions, Fed Decisions, or direction of the overall index. Soybeans however, can’t “cook their books.” Silver can’t be declared “too big to fail.”
Knowing the fundamentals of a commodity, such as crop sizes and demand cycles, can be of great value when selling commodities options.
In commodities, it is most often old fashioned supply and demand fundamentals that ultimately dictates price. Knowing these fundamentals can give you an advantage in deciding what options to sell.
Commodities Option Selling – An Example
The example below illustrates these key concepts of selling a futures option. This is for example purposes only and assumes the seller is neutral to bearish crude oil prices. Note particularly the distance of the strike from the underlying trading price as well as the margin vs. premium collected. Then compare these to their counterparts in selling a call in Exxon or Chevron.
Also Important to Note: We are NOT selling a “covered” position or looking to buy crude futures “at a discount.” This is pure premium collection. No purchase of the underlying required (or desired).
EXAMPLE – Selling a Call Option – December Crude Oil
|Trade date:||July 20, 2014|
|Scenario:||An investor is neutral to bearish on crude oil prices and wishes to collect premium above the market.|
|Trade:||Sells December Crude Oil $130.00 call option|
|Expiration Date:||November 14, 2014|
|Summary:||If December Crude Oil Futures are ANYWHERE BELOW $130 per barrel at option expiration, the option expires worthless and the investor keeps the full premium collected as profit. Notice that the call can be sold at a level over 30% out of the money (Crude oil prices would have to rise by 30% prior to option expiration to go in the money.) The option could also be bought back at any time prior to expiration at a varying level of profit or loss. Bullish oil traders could use the same strategy by selling put options far beneath the market (although in hindsight, this would not have been advisable. Thus the importance of market fundamentals.)|
|Risk:||The risk to the put seller is that crude prices move substantially higher. If the option goes in the money, it could be worth more than he sold it for at expiration. At that point, he would have to buy it back at a loss. He could also choose to buy it back at any time prior to expiration, even if it was not in the money. This can be an excellent risk management strategy.|
• Note the margin requirement vs. premium collected is a 36.3% return on capital in 120 days, if the option expires worthless. Compare that to a successful sale of a stock option, where the return on equity is generally 1% to 2% per option – even on options with time values similar to this.
As a stock option seller, you cannot hope to learn all of the details of commodities options in one article. However, if you are a high net worth option seller seeking a diversified alternative to stocks and the potential for outsized returns, I strongly recommend our new booklet, The Option Selling Solution. It shows you how You can potentially achieve both bigger ROI and real diversification from stock options. You can get a FREE COPY of this New Booklet now at
Price Chart Courtesy of CQG, Inc.
***The information in this article has been carefully compiled from sources believed to be reliable, but it’s accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss, and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.