Comparing Commodity Options and Stock Options

Commodity and stock options are powerful financial vehicles but are often filled with confusion. Commodities include currencies, energy, grain, precious metals, livestock and meats, among others. Stocks, of course, relate to domestic and international company investment. Much of the following information was gleaned from the TradingSmarts.com and the Options Clearing Corporation's very informative websites and personal trading accumulated years ago. The following also assumes familiarity with basic options.

Similarities:

Both kinds of options consist of a seller and a buyer;

An option's premium is negotiated between a seller and a buyer;

The buyer's risk is limited while the profits can be unlimited;

On the other hand, the sellers risk is Unlimited while the seller profit is limited;

Both commodity and stock options offer 2 types of options, a call or a put.

The terms are exactly the same. Common terms are premium, time value, out-of-the-money, at-the-money, in-the-money, exercise price and intrinsic value.

Even their types of orders are the same. These include good-til-canceled order, limit order, market order, and stop order among others.

All options are versatile, meaning that the seller and the buyer have a number of strategies available to them, such as straddles and strangles.

Both commodity and stock options are "American-style" options, which mean that the buyer can elect to exercise (trade) the right at any time prior to option expiration. Generally, the buyer will not exercise the option, but will instead, close out the position before expiration of just let the option expire

The seller does not have the right to exercise an option. However, the seller will either close out the position prior to expiration or let the option expire.

Differences:

One of the main differences is that stock options do not have a futures contract as commodities do. Stock options may convert to 100 shares of the underlying stock at a specific price within a certain period of time.

Unlike (commodity) futures contracts, (which are a wasting asset); common stocks have no expiration date. This means that the buyer can continue to hold onto the stock indefinitely. On the other hand, all futures contracts expire, which means the buyer would have to close out the futures position by a certain dates if the option is exercised, or the buyer could be called to take delivery of the actual commodity.

Commodity options give more leverage because they (commodities) have larger contracts.

Dividends only apply to stock markets. Commodity (futures) contracts do not involve dividends at all.

Margin requirements are higher for stock options.

Commodity options are less standardized than stock options relative to expiration date. Depending on the type of commodity, commodity options expire at varying time frames.