OPTION PURCHASES

Option Purchases. The simplest trades are option purchases, or “long premium”. This can involve either the purchase of a call or put for a directional trade, or purchasing both together in a long straddle or strangle purchase. A straddle is the purchase of a call and put with the same strike price in the same contract month, and a strangle normally involves buying an out-of-the-money call and put with different strikes.

When we suggest an option purchase, we’ve reviewed other types of strategies and decided that an option purchase is indeed the best strategy for current market conditions. In this sense, the option purchase is not just a “simple” strategy, after evaluating many other more complex positions. Sometimes, an option purchase can be the most efficient and profitable use of capital.

Also, in certain markets, single options may be much easier to trade than spread positions or multi-leg trades. This can be especially true when the market gets busy and the floor is less accommodating about trading complex strategies. The varying futures markets have different expectations for slippage, ease of entry and exit, types of orders allowed, etc.

At the time the option purchase is suggested, a cost range is suggested. Also, we usually quote the most recent settlement for the options, and the price of the underlying market. We may specify limit entries, or use the price of the underlying futures to trigger entries. The time remaining until option expiration is also listed.

Risk for option purchases. In any outright option purchase, the amount of original money spent (the “premium”), is the most that is at risk (plus commissions and fees), and there is no additional margin requirement.

For option purchases of more than $500, we generally recommend risking about half of the premium for money management. However, other factors are taken into consideration, such as the time until expiration, individual risk tolerance, and whether the market attitude has changed.

For cheaper option purchases, we often “risk the premium”, or the original cost. There are many times when we’ve seen very cheap options “come back to life” if the underlying market makes a big move. An obvious example of this was in the gold market in the fall of 1999, when very cheap call options increased in value by 1000% or more during the huge rally at the end of September; the corresponding explosion in implied volatility added to the gains. All markets can occasionally have extremely large short-term moves that can turn inexpensive options into big winners. With some markets near multi-year lows, long option purchases with defined risk may be used as a variation of the classic “scale trading” strategy, and normal risk parameters might not apply. In this case you would continue to purchase additional options at successively lower market prices, and roll out to more distant contracts if time is running out for the nearby options. Eventually, severely depressed markets will rally from areas of fundamental “value”.

Suggested risk: Specific risk parameters are usually suggested. Besides basing risk on the value of the option itself, we may use the price of the underlying futures to trigger risk control. Whether you use our risk guidelines or not, be sure to have a trading plan that uses proper money-management for your account size.

Objective or trading target: As a new trade begins, we often set a trading goal or an “initial trading target”. If this is reached, a new evaluation of the market can indicate whether to take gains or let profits run. There may also be opportunities to make adjustments to convert positions to Free Trades, add more positions, adjust the entry point up to the entry area, or use a trailing profit stop.

Disclaimer: BECAUSE OF THE VOLATILE NATURE OF THE COMMODITIES MARKETS, THE PURCHASE AND GRANTING OF COMMODITY OPTIONS INVOLVE A HIGH DEGREE OF RISK. COMMODITY OPTION TRANSACTIONS ARE NOT SUITABLE FOR MANY MEMBERS OF THE PUBLIC. SUCH TRANSACTIONS SHOULD BE ENTERED INTO ONLY BY PERSONS WHO HAVE READ AND UNDERSTOOD THIS DISCLOSURE STATEMENT AND WHO UNDERSTAND THE NATURE AND EXTENT OF THEIR RIGHTS AND OBLIGATIONS AND OF THE RISKS INVOLVED IN THE OPTION TRANSACTIONS COVERED BY THIS DISCLOSURE STATEMENT.