The Difference Between Options and Futures
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I'm a huge fan of trading commodity options. And you should be, too. But there are some nuances when trading commodity options that you have to consider if you're going to move some capital away from equities. These 3 differences are the most important concepts to understand, as they can potentially change the way you trade these instruments.
If there is one thing to learn about options is that each contract will have a different implied volatility. You can visualize implied volatility over various strikes by looking at the volatility skew. Notice that as we go lower in strike, the implied volatility on each contract options trading on stocks and commodities. This is because option traders are willing to pay options trading on stocks and commodities for "tail-risk" protection, and most hedgers in equities are fearful of downside.
Instead of a "skew" we now have a "smile. It comes down to the perception of risk. Equity investors are fearful of downside in equities. But in commodities like gold, oil, options trading on stocks and commodities, and currencies the perception of risk is bi-directional. So when hedgers and speculators come out to commodity options, they fear strong moves in either direction. This changes the strategy set used in commodity options trading-- iron condors become more attractive, as do ratio sales after extreme moves.
Single stock equities can be driven by upgrades, downgrades, earnings, FDA events, insider selling, holding updates, institutional rebalancing, intermarket correlation, same store sales This heightened risk produces higher potential reward-- and for those that want to get more conservative, trading indexes or index futures can mitigate that risk.
With commodity options, the risks that drive movement are quite different than what drives equities. It could be based off supply reports or interest rate changes by central banks.
Because the risks are different, it can give you a way to diversify your trades against different options trading on stocks and commodities. This can be crucial when finding the best trades. Joe farmer needs to sell his soybeans. Spacely Sprocket company needs to hedge their Euro risk. ZeroHedge has to buy more silver to combat the manipulators.
They look to buy stock in companies. Contrast that to gold and oil: From a structural standpoint, they aren't "investments. I see two possibilities heading into the summer months. If we get the first scenario, then correlations will ratchet up among stocks and it will be a macro game again.
If the second comes along, then summer volatility and liquidity in equities will dwindle. Either way, commodity options trading is definitly coming back into my trading arsenal for the next few months. I've put together an Iron Condor Trading Toolkit that gives you the case studies and training needed to be consistently profitable in the market.
Click Here to Get the Toolkit. Fear is In Both Directions If there is one thing to learn about options is that each contract will have a different implied volatility. That means the tail risk can be on either side. Commodities Have Different Event Based Risk Single stock equities can be driven by upgrades, downgrades, earnings, FDA options trading on stocks and commodities, insider selling, holding updates, institutional rebalancing, intermarket correlation, same store sales Why is risk bi-directional?
Because the motivations in the commodities market are completely different than stocks. What's going on right now