Commodity Futures EquivalentA commodity futures equivalent is a calculated comparison of value between futures contracts and options contracts on commodity futures. Commodity futures trading and commodity futures options trading both deal with the future price of underlying commodities. A futures contract confers an obligation on both parties. The futures buyer must by and the futures seller must sell the commodity on the contract expiration date. Likewise selling puts and selling calls on commodity futures contracts requires that the seller honor the contract if exercised. However, the buyer of an options contract in the commodity futures market has the choice of exercising the option on or before its expiration date. The concept of a commodity futures equivalent is something that is more easily understood after Commodity and Futures Training or Options Training with Stephen Bigalow.
The futures equivalent of an option contract or set of contracts is obtained from the number of options and the risk factor or delta factor of the options. The delta or risk factor is how much an option contract will change in value if the underlying futures contract changes by one unit. Thus 20 option contacts with a risk factor of 0.1 will be 2 futures equivalent contracts. The commodity futures equivalent is calculated from the number of options contracts in hand and the previous dayís delta or risk factor. This calculation is a useful tool for the options trader for comparing the relative values of futures trading to options trading of the futures market on the same commodity with the same expiration date. When used in conjunction with technical analysis tools such as Candlestick charting the futures equivalent will help traders choose trading options markets on futures or futures markets on commodities themselves.
Trading options on futures contracts may seem excessively complicated to some interested in developing options strategies or planning to simply trade futures. What futures and options together provide is the choice of exercising a futures contract or not. Trading futures contracts by way of options allows for trading futures that are considered more speculative and more risky with less risk. Buying an option gives the trader the choice of executing the option and thus buying or selling a futures contract. In an extremely volatile market in commodities this may be a good way to manage investment risk while maintaining the possibility of trading when the conditions are right.The cost of options trading the futures market can be more that simply trading commodities. The trader will pay a premium for buying puts or buying calls that he or she would not pay when simply trading futures. This cost, of course, must be added to the cost of futures trading when deciding if buying an option is worth what is effectively an insurance premium. For those who avoid a devastatingly bad move in the futures market of a commodity the insurance will be worth it. They will not have entered a bad position and they will not have paid to buy or sell a futures contract. For those who are trading in stable markets the cost may not be worth it as a trader can always get out of a futures position by buying back an equivalent futures contract or selling a contract equivalent to what he or she previously bought. The use of the commodity futures equivalent calculation can be helpful in deciding whether to trade futures or options on futures.
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