Commodity put option
SummaryA commodity put option is a contract that grants the producer the right but not the obligation to sell a specified quantity of a commodity to the consumer at a fixed price before a stated future date.
What is a commodity put option?
A commodity put option is a contract that grants the producer the right but not the obligation to sell a specified quantity of a commodity to the consumer at a fixed price before a stated future date.
The purpose of a commodity put option is to establish a minimum income from a future sale of a commodity. It limits the downside risk while maintaining the ability to trade at a higher spot rate if market prices rise.
How does it work?
An oil company knows they will have produced 500 barrels of oil in a year’s time. They do not want to pay for storage any longer than necessary and do not want to sell the oil for less than $105 a barrel. They buy a put option with a strike price of $105. If the price falls below this level they will exercise the option and have the right to sell oil to the buyer at $105 per barrel. But if the price is above the strike they can allow the option to expire and sell their barrels at the market rate.
- Provides the producer with a minimum income
- Gives the producer the opportunity to benefit from higher prices
- The producer will incur a premium cost, usually paid up-front
- If prices rise above the strike rate during the tenor of the option, the producer may feel they received no value
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.20-0291
Our featured insights
Chatham's Q4 2022 outlook: Inflation, market volatility, and LIBOR transition
Watch Chatham's Managing Partner and Chair, Amol Dhargalkar, discuss key trends for the upcoming quarter like inflation, market volatility, and LIBOR transition.
Chatham Financial announces CEO transition effective January 2022
Matt Henry named the next Chatham CEO
Clark Maxwell and Laura Grant: 30 years of bringing knowledge, data, and tools to the capital markets
Clark Maxwell and Laura Grant talk about how Chatham continues to bring a combination of knowledge, data, and tools to the capital markets. Chatham Financial is celebrating 30 years of serving our clients.
Chatham Financial wins Hedging Adviser of the Year at the Risk Awards
On November 26, Chatham Financial accepted the inaugural Hedging Adviser of the Year award at the 2020 Risk Awards. This new award recognizes excellence in providing independent advice to derivatives users.
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.
Chatham crowned Risk Management Advisory Firm of the Year
JCRA, now part of Chatham Financial, the independent financial risk management advisory, is delighted to announce that it has been recognised as Risk Management Advisory Firm of the Year at the GlobalCapital Global Derivatives Awards 2019.