1: WHY ARE OPTIONS ON FUTURES SUCH A POPULAR INVESTMENT?
Having a known and limited risk, purchasing options makes it possible to realize a potential profit in a short period of time. However, commodity trading is not suitable for everyone. It is speculative in nature and a substantial risk of loss exists. Other advantages include; Liquidity, Diversification, flexibility to respond quickly to different opportunities, ability to monitor option values, staying power during times of price set backs, no margin calls and the opportunity to realize profits on both declining and rising prices.
2: WHAT ARE OPTIONS?
They are investment vehicles that give you a tremendous amount of leverage over a specified period of time. There are two types of exchange traded options known as "call" options and "put" options.
·Call options
Give you the right, but not the obligation, to buy a commodity futures contract that you anticipate will go up in value.
·Put options
Give you the right, but not the obligation, to sell a commodity futures contract that you anticipate will go down in value.
If, for example, you expect the price of a commodity to go up, you would purchase a call option. If you anticipate the price of a commodity to go down, you would purchase a put option.
3: BESIDES CALL AND PUT OPTIONS, WHAT OTHER TERMS SHOULD I KNOW?
There are a large number of industry-specific terms that you should be familiar with before trading in commodities. We have compiled a list of these terms in our Resources section.
4: HOW MUCH CAN I LOSE IF I BUY AN OPTION?
The risk of loss is a great question to ask of any investment. In the purchasing of options, the maximum risk is that you could potentially lose all the money you have paid for that option (premium), including commissions and fees.
5: IS THIS A RISKY INVESTMENT?
Yes it is. That is why an Account Advisor at Hanover Brooks takes the time to ask you so many questions. They want to help you determine your suitability and tolerance for risk. Your Account Advisor needs to understand your financial situation and objectives and will require that you read and understand a Risk Disclosure Statement prepared by Hanover Brooks. This information should be a strong consideration in deciding whether options are an appropriate investment for you. Only monies considered "risk" investment capital should ever be used in any investment that involves substantial risk, regardless of the potential for profit.
6: HOW DO YOU MAKE MONEY IN OPTION INVESTING?
By telling your account advisor to sell your option rights to someone else. The sale will be made on the same trading floor of the exchange where the option was originally purchased. Your net profit will be the difference between your retail purchase price (premium, commissions and fees) and your selling price.
7: HOW MUCH PRICE MOVEMENT IS NEEDED TO SEE A PROFIT ON MY OPTIONS?
Realizing a profit on call options at expiration requires that the commodity price be above the option strike price by an amount greater than your retail purchase price (premium, commissions and fees). Realizing a profit on put options at expiration requires that the commodity price be below the option strike price by an amount greater than your retail purchase price (premium, commissions and fees).
8: HOW MUCH MONEY CAN I MAKE WHEN I BUY AN OPTION?
Your profit potential is unlimited. Provided the price movement is within the life of your option, the greater the move, in the direction anticipated, the greater the profits. As stated previously, the combination of limited risk and unlimited profit potential is one of the attractions of purchasing options on futures contracts.
9: WHAT EXCHANGE TRADED OPTIONS CAN BE BOUGHT?
Exchange traded options have grown rapidly and include a broad range of energy products, precious metals, agricultural products, foreign currencies and financial instruments, to name a few. Contact us for current recommendations.
10: HOW ARE OPTION PREMIUMS ARRIVED AT?
Remember, premium not only refers to the price you pay for an option, but also the price you receive for your option, if and when you sell it. Option markets are supply and demand marketplaces. Premiums are arrived at through open competition between brokers on the trading floor or market makers who represent buyers and sellers
11: WHAT AFFECTS PREMIUM VALUE?
There are three factors:
- I) STRIKE PRICE
- In the case of call options, the most valuable ones are those that have the right to buy at a low price. So, everything else being the same, a call option with a lower strike price cost more to purchase, than a call option with a higher strike price. The opposite is true for put options. The more valuable put options are the ones that have the right to sell at a higher strike price. So, everything else being the same, a put option with a higher strike price costs more to purchase, than a put option with a lower strike price. - II) TIME TO EXPIRATION DATE
- The longer term options provide more time for your price expectation to be realized. Thus, all else being equal, an option with more time to expiration demands a higher premium than an option with less time. - III) VOLATILITY
- Volatility is what best provides price movements that can make options valuable. Thus, all else being equal, premiums are usually higher when markets are volatile.
12: WHAT IS THE LIFE OF AN OPTION?
It varies greatly. From less than a month, to over a year. You have your choice. This makes it possible for you to pick the time you think will be appropriate for a potential price movement to happen. Don't hesitate to ask an account advisor for help in deciding how much time to consider when purchasing options.
13: WILL THERE ALWAYS BE A CONTINUING MARKET FOR THE OPTIONS BUY?
Generally, the markets are active in outstanding options all the way to the date of expiration. However, if your options are deemed to not have much of a chance of ever becoming worthwhile to exercise, there may not be a market for them.
14: CAN OPTIONS BE SOLD IF THEY ARE NOT WORTHWHILE TO EXERCISE?
Yes, if there is still active trading in that particular option. A profit or loss will depend on whether you sell your options for more or less than your retail purchase price. If prices have not moved in the direction anticipated and you no longer want to own the option, selling it before expiration may be a way of recovering a portion of your investment.
15: IF AN OPTION I'VE PURCHASED QUICKLY BECOMES PROFITABLE, CAN I SELL IT?
Yes. Throughout the life of an option, the decision of selling is completely up to you.
16: WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF "LEVERAGE"?
Options provide great leverage. This means that even a slight favorable move in the underlying commodity price can return a high percentage rate on your investment. If the option isn't worth selling or exercising by expiration, you could lose your entire investment in that option (premium, commissions and fees).
17: WHAT IS MEANT BY "POSITIONING"?
Major price movements typically occur in response to economic or political events. Once these events occur, there may not be an opportunity for small investors to be part in the resulting price move. Positioning yourself to potentially profit, if and when anticipated events and price moves occur, is another attractive feature of purchasing options. Timing is obviously the key to any investment.
18: WHAT SHOULD I KNOW ABOUT THE COMMODITY I'M CONSIDERING?
The reason people purchase options is because they have an opinion about a potential price move of a particular commodity. Many people will deal with a brokerage firm to discuss the various opportunities available and the reasons why.
19: WHOM AM I BUYING THE OPTIONS FROM?
Options are purchased from someone who engages in a very speculative area of investing known as option writing. They are sometimes referred to as grantors. They stand to make money if and only if, your options at expiration are worth less than what you paid for them. Contrary to the limited risk in purchasing options, writing or granting options involves the potential for unlimited risk.
20: WHOM MAKES PAYMENT OF EXCHANGE TRADED OPTIONS?
If and when your options become profitable, the monies needed to pay you are collected from the option writer on the other side of the transaction. This is done through the brokerage firms and clearing organizations of the exchanges where options are traded.
21: HOW CAN I FOLLOW AN OPTION'S CURRENT MARKET VALUE?
Options on futures contracts are traded on various regulated exchanges and over the counter markets that have continuous electronic quotation systems. You can follow option premiums via the Internet, major newspapers, or you can also phone your Account Advisor. Being able to follow your investment is another attraction of options.
22: WHO IS IN CHARGE OF MY ACCOUNT?
You are the final decision maker on all transactions in your account. At Hanover Brooks, we will be happy to make good faith recommendations and provide current information to help assist you in making your decisions.
23: HOW DO I KNOW I AM DEALING WITH A LEGITIMATE COMPANY?
Review the firm’s documentation to see if they provided you with a risk disclosure document. A compliance department is utilized by the firm in the effort to know the client and to make sure all the risks associated with commodity trading has been fairly explained and that the customers funds is risk capital. Make sure the company your looking to do business with has this department.
24: HOW CAN I WITHDRAW FUNDS FROM MY ACCOUNT?
By simply calling your account advisor or email your request. All funds are sent via electronic bank transfer and your account advisor must have the appropriate instructions that are provided by your bank.
If you have any further questions feel free to contact us today and we will be happy to assist you.