The commodity options trading system basically consists of a market in which producers may purchase the opportunity to sell or buy a commodity at a certain price. This is similar to a situation where a farmer may purchase the right from an insurance firm to collect on a policy in case his buildings burn, he can purchase the right to sell his commodities at a specific price if market prices go below the specified price.
In fact a separate market exists where purchase of the right to buy commodities at a specified price of market prices are higher than the specified price. Therefore, effectively there are really two separate commodity options trading systems – one where it is possible to insure products being sold against price declines, and another where it is possible to insure products purchased against price increases.
People who participate in the commodity options trading systems have the opportunity but not the obligation to exercise their agreement. This is the reason that the system is appropriately named the option trading system since they deal in an option, not an obligation.
To explain this concept further, for instance, if a person desires to buy the right to sell a given commodity for a certain price, the commodity options market provides the opportunity. By paying the market-determined premium, the person could then collect on the option if prices are below the price at which the deal was finalized when the corn would actually be sold. If prices are higher than the price at which the deal was finalized, the commodity could be sold for the higher price and the cost of the premium is absorbed.
As mentioned, there are actually two basic types of commodity option trading systems: a call option and a put option. The call option gives the holder the right, but not the obligation, to buy the underlying commodity from the option writer at a specified price on or before the option’s expiration date.
On the other hand, the put option gives the holder the right, but not the obligation, to sell the underlying commodity to the option writer at a specified price on or before the option’s expiration date. The call option and the put option are two distinct contracts.