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Guide

Commodity call option

Summary

A commodity call option is a contract granting the consumer the right but the not the obligation to buy a specified quantity of a commodity from a producer at a set price before a fixed future date.

What is a commodity call option?

A commodity call option is a contract granting the consumer the right but the not the obligation to buy a specified quantity of a commodity from a producer at a set price before a fixed future date.

Objective

The purpose of a commodity call option is to establish the maximum cost of a future commodity purchase. The buyer profits when the goods increase in market price.

How does it work?

An oil consumer knows they will need to purchase 500 barrels of crude in a year’s time. They do not want to pay more than $105 per barrel and do not want to pay for storage. They buy a call option with a strike of $105. If oil prices rise above this level before the expiry of the contract, the consumer can exercise the option and pay $105 per barrel. If the market price is below the strike price, (e.g. $100) they can buy barrels at the market rate and allow the option to expire.

commodity call option table

Three scenarios of where the market price could settle and what the borrower will need to pay.

Advantages

  • The consumer knows the maximum cost of a commodity
  • Allows the consumer to pay lower prices should the spot price fall below the strike price

Disadvantages

  • The consumer will incur a premium cost, usually paid upfront
  • If prices fail to rise above the strike price during the tenor of the option, the consumer may feel they received no value
commodity call option trade description

An example of what a commodity collar option trade could look like.

commodity call option graph

Commodity call option graph showing three potential outcomes over time.


Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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