Commodity Options

What happens if an agricultural producer would like to secure the price he will be paid for the future crop, but doesn’t want to commit to a futures contract in case the harvest is bad? He might have to buy additional crops in the market at the then current price to satisfy the amounts he had promised on the futures contract. To meet this need, commodity options were introduced.

A commodity option is not an option to buy or sell physical commodity, but an option to buy or sell a futures contract on the commodity. So by buying an option, the farmer can buy insurance that he will get a good price without fully committing to the production level. Given the unpredictable nature of the weather, and hence the crop, it can be a good plan to take futures contracts for the minimum crop expected, and have options for the rest. In this way, the farmer will receive full value from the futures contracts regardless of the amount of the harvest. If the yield is good, then he can exercise the options to “put” or supply the remainder of the crop at the option price.

Currency Options

With a currency option, you get the right but not the obligation to exchange two currencies at a predetermined rate at a certain date in the future. Effectively, that includes both a call option and a put option, as you have the right to sell a currency and the right to buy another currency.

They can be used by financial houses, banks and corporations to hedge against adverse currency moves for a future transaction. As opposed to a futures contract, if the currency moves in favor of them, the business can benefit from it rather than being stuck with the rate they agreed. To offset this, the business will have had to pay the cost of the option which gives them this guarantee.

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