Futures options on commodities: Gold, coffee, wheat, crude oil

I. Futures options vs. stock options:
Diversification

If you do not want to worry about when North Korea will fire another missile, where it will land and what will be the impact on your stock portfolio, you might also consider looking for other opportunities than those offered by the stock market. Therefore, let’s have a look at futures options.

To be clear, I think there are very good opportunities in stocks. The bull market in the last years has been great for many investors and traders and it might also be so in the next years. I cannot foresee the future, but I can see the current market in this particular moment. After the S&P 500, the index listing five hundred of the largest U.S. companies, has increased about 9% and Nasdaq 100, listing U.S. technology companies, increased even more than 20% since the beginning of this year, the stock market has become very sensitive. There is fear resulting in regular sell-outs, which has been bought back (up until now). Hence, and as promised in my previous article, I would like to share a few ideas about how to create a safer and more balanced portfolio.

I have found my way to be active in the financial markets by selling options. To know more about how options work, check out the “OPTIONLAND”. You can basically sell options on:
• stocks or
• futures contracts.

The stock options are very much influenced by the development in the stock markets. However, the futures options are a different story. The futures contracts basically reflect the price of different commodities, like grains (wheat, corn), metals (gold, silver), meat (live cattle) or currencies (USD/EUR) in a future date. The futures options then respectively follow the changes in the futures contract, be it wheat, gold, crude oil etc.

To understand the differences between stock and futures options, I will focus on the following key points:
– diversification;
– option premiums;
– liquidity;
– possibility to “repair” trades;
– margin;
–  and other peculiarities.

In this article, I will start with the first point: “diversification” and I will explore the other key points in the next posts on my blog. Stay tuned.

Diversification offered by futures options

We are all aware of the “friendly advice” from our brokers to diversify our portfolio. There might be a little conflict of interest by the fact that the more positions we open and close, the more commissions the broker will collect. Nevertheless, to some degree, diversification is very important. I do not want to bet everything on one horse.

The stock market does not offer much diversification. Once there is a major correction, it does not matter whether you have positions in 20 different stocks, it will very likely behave as one. We can have stocks from different sectors, such as Apple, Starbucks, Volkswagen or Pfizer. However, what will happen when, there is a crash? Each one will drop like a bag of potatoes. Usually, utilities stocks (e.g. energy providers) will fall less then technology stocks, but pretty much everything will fall.

The futures options offer a real diversification to your account. Unlike stock options, futures options allow you to hold positions which do not correlate with each other (their price movements are not similar). The price movement of Live Cattle does not have much to do with the price of US Treasury Bonds or Cotton. Wheat or Corn prices are not influenced by the changes in the stock market. Actually, you might balance your position in the stock market by opening some positions in assets which are considered as “safe heavens” (Bonds, Gold) that usually increase in value when stocks fall.

One thing is certain, your position will not behave as one. That is why, it is always good to explore new fields and  broaden your horizon. Selling some futures options might help to eliminate risk in one’s portfolio.

Let me know, what do you think about selling futures options and share your experience.



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