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As we all know, commodities are goods which are uniform in appearance and utility, regardless of their source.
Investors choose commodities to diversify and to use arbitrage opportunities.
There are many ways to directly and indirectly invest in commodities.
Today, we will discuss the use of options to do so.
An options contract is a right, but not an obligation, to trade underlying securities at a fixed price, on a fixed date in the future.
There are two types of options – calls and puts.
An options contract which gives the right to buy the underlying assets at a fixed price is a call option.
On the other hand, a put option gives the right to sell the underlying securities at a fixed price.
Now, when it comes to commodity options, the underlying securities are commodity futures.
This is because the spot market for shares is regulated by state governments, whereas the derivatives segment is regulated by the central government.
Therefore, a commodity options consists of a derivative, with an underlying derivative.
These options are usually traded European-style.
This means that you will not be able to exercise the option before its expiry.
To invest in these options, you will need a trading and demat account on a recognized trading terminal.
You can trade options on most recognized stock exchanges of the country.
Now, let us discuss the pros and cons of investing in commodities through options.
The biggest advantage of using an option is the right to not exercise the contract at all.
This provides limited losses to an options buyer, and it can be even more useful in a volatile commodities market.
However, there are intricate rules and regulations in options trading, which have to be well understood before you can invest through them.
Also, options, as well as commodities are highly volatile. Therefore, they are not suitable for risk-averse investors.
The biggest drawback is that you will have to research three things extremely well to make profits here – options, commodities and futures.
This can be tough for an investor who has only invested in equities before, as the level of difficulty is higher here.
As an informed investor, you should think about these factors before you make a decision to invest in commodity options.
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