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Commodity Futures Options

What is the advantage of trading commodity futures options versus commodity futures? When trading futures in volatile commodities markets, there is substantial opportunity for investment reward as well as investment risk. One means of reducing risk in commodities trading is to trade options on futures contracts. For example, buying calls and buying puts on corn futures does not obligate traders to buy or sell corn futures. Buying options in the commodities market provides the opportunity to enter the futures market if the prices are right. On the other hand selling calls and selling puts is done when the trader believes that market in a commodity will be stable during the term of the options contract. This is often a more profitable approach long term but requires the ability to withstand an occasional large loss. A good way to learn options trading in the commodities markets is to take Options & Futures Training or Options Training with Stephen Bigalow.

Commodity futures options are a risk management tool. Just as commodity producers use commodity investing as a hedging strategy to guard against commodity price fluctuation speculators use options trading. The premium for commodity futures options is a cost of doing business. This cost is offset by traders not needing to pay trading fees if options contracts are not exercised. The premium becomes insignificant in the event of a substantial and profitable market move.

Commodity futures options typically provide the buyer with the right but not the obligation to buy or sell a futures contact up until contract expiration. However, there are some new ways to trade options including corn calendar spread options. These are options contracts on the month to month variation in futures contract prices. In general commodity futures options reduce trading risk and act as a way of leveraging capital for potential gain. As stated by the Chicago Mercantile Exchange, “With options, traders can construct [trading strategies] that profit in advancing, declining or even stable markets, while at the same time reducing risk and increasing leverage. In addition, because options also can be used to protect against adverse price moves in livestock, interest rate, foreign exchange and equity markets, they have become an increasingly popular hedging vehicle. Today corporate treasurers, bankers, farmers and equity portfolio managers throughout the world benefit from using options as risk management tools.”

The very same options strategies that work for other equities are applicable in commodity futures options. Traders often engage in long straddles by buying both a put and a call on a commodity future. The contracts are for the same commodity and expiration date. This strategy works well in a volatile market as the trader will profit from either an up turn or down turn in commodity prices. If the commodity price does not change the trader’s cost is two premiums. In the case of a stagnant market a trader engaging in a short straddle strategy will profit by selling a put and a call on the same option for the same expiration date. As in all futures and options trading the use of technical analysis tools such as Candlestick chart formations will help the trader see the market more clearly.

Market Direction: Wednesday's 100 point move in the market was the first extremely strong day in the last six weeks. It moved the Dow away from the tee line. This is usually an indication to watch for some profit-taking. However, the uptrend has experienced a few days where the market indexes moved away from the tee line, such as around March 5 and March 22. Instead of a selloff back to the tee line, the markets moved sideways until the tee line caught up. That was the sign of a strong uptrend. Is that going to be the case now?

Candlestick signals incorporate an immense amount of information. That information can be extracted on a daily chart or on an intraday chart. Today's trading resulted in a slightly positive day. This could represent some indecisionon a daily chart basis. But the analysis of the intraday charts can give a much more accurate view of what occurred in today's trading. Although the price movement was not very great, the manner in which the markets traded indicated that profit-taking was occurring during the day but the Bulls remained in control. The strength of a market trend can be seen in the intraday movements. A price trend that moves up dramatically has the probability of pulling back dramatically because of profit-taking. A trend that moves slowly and consistently, with the profit-taking occurring along the way, will have a much longer and stronger duration. That is exactly what this market trend has been doing.

Fortunately, the longer a trend continues without a dramatic change of investor sentiment, the more opportunity there is for candlestick patterns to perform. Whether you are trading stocks or commodities, applying simple confirming indicators to a candlestick chart pattern dramatically improves the probabilities of being in the right position at the right time. The visual aspects of candlestick signals makes the analysis of profitable trades very easy. Use this information to your advantage. The basis of the simplicity of candlestick analysis reverts to the fact that investor sentiment creates the same reoccurring price patterns. Once you have identified how to recognize those patterns, you create a trading platform that constantly puts the probabilities of being in the right position at the right time.


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Good Investing,

The Candlestick Forum Team

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