Hedging Commodity Price Risk with Options

We saw earlier that there are futures contracts available for a variety of basic commodities. In addition, there are an increasing number of options available on these same commodities. In fact, the options that are typically traded on commodities are actually options on futures contracts, and, for this reason, they are called futures options.

The way these work is as follows: When a futures call option on, for example, wheat is exercised, the owner of the option receives two things. The first is a futures contract on wheat at the current futures price. This contract can be immediately closed at no cost. The second thing the owner of the option receives is the difference between the strike price on the option and the current futures price. The difference is simply paid in cash.

The Chicago Board Options Exchange (CBOE) is the world's largest options exchange. Make a virtual visit at www.cboe.com.

A good introduction to the options markets is available at


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The Derivatives 'Zine at www.margrabe.com covers risk management.


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