Where to Trade Commodities

• Options on commodity products can be traded on regulated exchanges, or within an over the counter market (OTC). The most active regulated exchange for commodity products is the Chicago Mercantile Exchange. This exchange offers its clients futures on commodities, as well as, options on futures on commodities. The products are regulated by the National Futures Association, and the Commodity Futures Trading Commission. Within the over-the-counter market, counter parties trade commodity swaps, forwards, and options with one another based on private contracts.
  
  

Futures

• Futures contract on commodity products can be settled either physically or financially. A physical futures contract is the obligation to either buy or sell a specific commodity on a specific date in the future. A financially settled futures contract requires the exchange of money for the different between the purchase price and the sale price of the commodity future.
  
  

Options

• Options on futures contracts are the right, but not the obligation to purchase either a physically settled, or financially settled commodity future on a specific date, known as the expiration date, at a specific price, known as the strike price. The buyer of a commodity futures option will pay a specific amount of money, known as the premium to the seller of the commodity futures option. This premium is determined by the market and fluctuates with market sentiment.
  
  

Techniques

• Investors who are speculating on the commodity markets have a number of techniques that can be utilized when trading commodity options. Two of the most common techniques are outright purchases and sales, as well as, covered calls and protective puts.
  
  

Outright Purchase

• An outright purchase is utilized when an investor believes the price of the commodity will rise or fall. This strategy also limits the risk of the trade to the premium of an option. When purchasing a call option, and investor is speculating that the price on the underlying commodity will rise during a certain period of time. When purchasing a put option, an investor is speculating that the underlying price of the commodity will fall during a certain period of time.
  
  

Covered Calls / Protective Puts

• A covered call or protective put strategy is used by an investor to protect the value of a portfolio of assets. A covered call strategy is one in which the investor sells a call option, and collects the premium from the call in return for potentially giving up the equity owned at a higher level. A protective put strategy is a strategy where the investor buys a put to protect the value of his portfolio. If the market moves lower, the assets in the portfolio will lose value, but the value of the put will increase, and somewhat offset the loss in the value of the portfolio.