Selling options is a little known strategy to new commodity traders, but it is widely used among professional traders. Selling options and writing options are two terms that virtually have the same meaning.
In order for an option contract to be created, someone must buy an option and someone must sell (or write) and option. Just as in futures contracts, you can initiate a trade by buying or selling a contract. The same thing is done with futures options. When you sell an option that you don’t already own, you are granting the buyer of the option the right to buy (for call options) or sell (for put options) a futures contract at the strike price any time before the option expires.
In return for granting the option buyer these rights, he will pay you a premium for the option. This concept is very similar to how the gaming industry works. The house takes the bet and the wager is the amount paid for the opportunity to make money. Therefore, the house is considered the option seller and the person placing the bet would be the option buyer.
An example of selling a futures option:
- You sell a July $7.00 soybean call at 15 cents or $750 (.15 x 5,000 bushels).
The buyer pays you the $750 premium for the option you sold. This money is put into your account. In order to secure the position, the futures exchange will require you to put up margin in excess of the money you received from the buyer. That amount will vary, but it will not be higher than the margin requirements for a futures contract. Normally, the further the option is out of the money, the less margin that is charged.
At this point, there are a few things you can do to manage this short option position.
- You can close the option at any time (during market hours) by placing an order to buy the option. You will have a profit or loss depending on your sell price and your buy price.
- You can hold the option until it expires. If it expires out of the money, you will have made a profit on the whole premium you collected and nothing further needs to be done. The option would have no value if it is out of the money at expiration.
- If you hold until expiration and the option is in the money, the buyer will likely convert it to a futures contract at the strike price. Therefore, the futures exchange will put a futures contract in your account (long if it is a put and short if it is a call). Then, the option goes away and you have to close the futures position in order to close the trade. You still retain the premium you collected on selling the option, but you might have a profit or loss depending where the futures contract is trading.
