Wednesday, October 22nd, 2014

How to Buy Oil Options

 

The oil market is often very volatile. Crisis in the Middle East, turmoil in Ukraine and rebellion in Nigeria all threaten to drive oil prices up. Fracking technology is driving the USA toward not only oil and gas independence but a renewed status as an exporter. This fact promises to drive oil prices down. A viable way to deal with the volatility of the oil market is trading oil options. We have written about analysis and strategy in relation to trading options on oil stocks, oil exploration companies and options on oil futures. Now, as a practical matter we talk about just how to buy oil options.

Options on What

As noted above you can profit from price movement of big oil stocks, oil exploration stocks and oil futures. How to buy oil options is pretty similar no matter which way you go. In the USA, traders trade futures on the NYMEX. Traders trade options on the CBOE, the Chicago Board Options Exchange. Big oil stocks and oil exploration stocks trade on the NYSE. Today we will look at how to buy oil options on oil futures using the CBOE.

Chicago Board Options Exchange: CME Group

In this article we are interested in options on futures contracts, specifically crude oil futures. Here is the Options on Futures definition from Investopedia:

An option on a futures contract gives the holder the right to enter into a specified futures contract. If the option is exercised, the initial holder of the option would enter into the long side of the contract and would buy the underlying asset at the futures price. A short option on a futures contract lets an investor enter into a futures contract as the short who would be required to sell the underlying asset on the future date at the specified price.

Regarding crude oil futures and options, here is what the CME Group says about Light Sweet Crude Oil futures and options:

Light Sweet Crude Oil (WTI) futures and options are the world’s most actively traded energy product. Customers around the world have sought out WTI futures for price discovery and risk management for more than 25 years.

How to buy oil options is to set up a trading platform that is compatible with your broker and then trade crude oil futures options via that platform. Then the issue is how to make money in the process.

Fundamental and Technical Analysis

And we come full circle. The world of oil prices can be very volatile. The same volatility can lead to profits or losses. Those who stake out solid positions with options trades typically make money. Those who use options when buying oil futures are able to limit any losses to the amount of the options contract. To make money in this world the trader needs to be familiar with the factors that drive oil prices and up to date with what is happening to those factors. This, in the end, follows the law of supply and demand and successful options traders make money in oil options by understanding both the market fundamentals and short term market sentiment.

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