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Commodity Options
By: Brittain, Paul; Garner, Carley

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Investors worldwide are discovering the enormous opportunities available through commodity options trading. However, because commodities have differing underlying characteristics from equities, commodity options behave differently as well. In this book, two of the field’s most respected analysts present strategies built from the ground up for commodity options.

Carley Garner and Paul Brittain begin with a quick primer on how commodity options work, how they evolved, and why conventional options strategies often fail in the commodity options markets. Next, using detailed examples based on their own extensive research, they show how to leverage the unique characteristics of commodity options in your own trades. You’ll walk through trades from “top to bottom,” master both long- and short-option approaches, and learn powerful strategies usually ignored in options books. For example, the authors introduce synthetic swing trading strategies that systematically remove volatility from the market.

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Table of Contents:

Introduction xix

Chapter 1: Option Basics: A Crash Course in Option Mechanics 1

    What Is an Option? 1

    Strike Price 2

    Intrinsic and Extrinsic Value: Components of an Option Price 3

    Intrinsic Value 3

    Extrinsic Value 5

    Time Value 6

    Volatility 7

        Trading Volatility 7

    Demand 7

    The Art of Option Trading 8

Chapter 2: An Option, Is an Option, Is an Option…Think Again 11

    Options on Futures, aka Options on Commodities 12

    Differences in Underlying 12

        Leverage 14

        Expiration 16

        Dividends 18

        Liquidity 18

        Nature of Market and Price Movement 19

        Standardized Point Value 21

        Stock Splits 22

    Difference in Option Markets 23

        Number of Products 23

        Technology: Electronic Versus Open Outcry 23

        Independent Futures Exchanges 24

        Liquidity 24

        Different Participants 25

        LEAPS 25

        Quote Availability 26

    Difference in Tax Treatment 26

        Long-Term Versus Short-Term 26

        Reporting Tax 27

    Difference in Regulators 27

        SEC 28

        NFA/CFTC 28

    Difference in Trading Tools 28

        The Greeks 29

        Black and Scholes Option Models 32

    Conclusion 34

Chapter 3: Long Option Strategies 35

    Why Long Options Aren’t Always a Great “Option” 35

    When to Use Long Options 37

    Alternative Uses of Long Option Strategies 38

    Factoring in Commission 39

    Long Call Option 40

        When to Use 40

        Profit Profile 40

        Risk 40

    Long Put Option 42

        When to Use 42

        Profit Profile 42

        Risk 42

    Neutral Long Option Plays 43

    Long Straddle 44

        When to Use 44

        Profit Profile 45

        Risk 45

    Long Strangle 49

        When to Use 49

        Profit Profile 49

        Risk 49

    Conclusion of Long Option Strategies 52

Chapter 4: Short Option Strategies 53

    Why Sell Options? 54

    Theoretically Unlimited Risk: Option Selling Can Be Hazardous to Your Wealth! 55

    Short Option Fundamentals 56

        The Premise behind Option Selling 57

        Preparing to Sell Options 57

    Technical Analysis and Option Selling 58

        Option Selling Isn’t Always Appropriate 58

        Reverse Break-Even 58

        The Execution of Option Selling 59

        Exercise Me! 60

    The Art of Adjustment 61

        The Double-Out Rule 61

        Sell More Premium 62

        Cover with a Futures Position 63

        Ratio Writes 63

    Short Call Option 64

        When to Use 64

        Profit Profile 64

        Risk 65

    Short Put Option 68

        When to Use 68

        Profit Profile 68

        Risk 68

        Option Selling Versus Trading Futures 70

        Don’t Underestimate the Risk of Illiquid Markets 71

    Short Straddle 72

        When to Use 72

        Profit Profile 72

        Risk 72

        The Reverse Break-Even Point 73

    Short Strangle 76

        When to Use 76

        Profit Profile 76

        Risk 76

Chapter 5: Credit Spreads 81

    Limited Risk Premium Collection 81

    Bullish or Bearish? 82

    Is Having Limited Risk Worth the Opportunity Cost? 82

    The Cons of Credit Spreads 83

    Bear Call Spread 84

        When to Use 84

        Profit Profile 84

        Risk 84

    Bull Put Spread 87

        When to Use 87

        Profit Profile 87

        Risk 87

    Iron Condor 90

        When to Use 90

        Profit Profile 90

        Risk 91

Chapter 6: Limited Risk Option Spreads 95

    Bull Call Spread 96

        When to Use 97

        Profit Profile 98

        Risk 98

    Bear Put Spread 100

        When to Use 101

        Profit Profile 101

        Risk 101

Chapter 7: Synthetic Swing Trading 105

    Why Swing Trading with Option Spreads? 106

    Trading Naked (It’s Not What You Think) 107

    Understanding the Risk and How to Cope 108

    Bull Call Spread with a Naked Leg 109

        When to Use 109

        Profit Profile 109

        Risk 110

    Bear Put Spread with a Naked Leg 115

        When to Use 115

        Profit Profile 115

        Risk 115

    Call Ratio Spread 119

        When to Use 119

        Profit Profile 119

        Risk 119

    Put Ratio Spread 123

        When to Use 124

        Profit Profile 124

        Risk 124

Chapter 8: The Other Ratio Spreads 129

    Call Ratio Back Spread 130

        When to Use 130

        Profit Profile 130

        Risk 130

    Put Ratio Back Spread 132

        When to Use 133

        Profit Profile 133

        Risk 133

Chapter 9: Limited Risk Range Trades 139

    Why Use Diamond Butterflies? 140

    Long Call Iron Butterfly 143

        When to Use 143

        Profit Profile 144

        Risk 144

    Long Iron Butterfly Put 147

        When to Use 147

        Profit Profile 147

        Risk 147

Chapter 10: Synthetic Long Option Plays 151

    Why Use Synthetic Positions? 151

    Be “Cheap” 152

    Synthetic Long Call Option 153

        When to Use 153

        Profit Profile 153

        Risk 153

    Synthetic Long Put Option 157

        When to Use 157

        Profit Profile 157

        Risk 157

Chapter 11: An Option Trade from Top to Bottom 165

    Identifying an Opportunity 165

Chapter 12: The Wizard of Oddz: Applying Option Strategies in the “Real World” 185

    Adjusting the Oddz 187

        Trading Extremes 187

        Take Advantage of Variations on Volatility 189

        Avoid Playing Economic or Agricultural Reports 192

        Only Buy Options Outright If “the Time Is Right” 193

Chapter 13: Margins and Option Trading 197

        How Margin Requirements Are Determined 198

        What Happens If I Get a Margin Call? 198

        Adjusting Margin Once a Margin Call Occurs 199

Chapter 14: Commodity Trading Myths 203

    It Is Easy to Make Money Trading 203

    I Made Money Paper Trading, So I Will Make Money in the Markets 204

    If It Is on TV or in the Newspaper It Must Be True 205

    If I Listen to the Experts, How Can I Go Wrong? 206

Appendix 211

Glossary 215

Index 251

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