ADVANTAGES
Profits:
You may profit from favorable price moves in your commodity while still protecting yourself.
Known costs:
The price of the option is paid for upfront at an agreed upon price.
Margin calls:
No margin calls (drain on your cash flow) if prices move favorably in your commodity.
You have already paid for the protection up front.
Flexibility:
- Price. If a “runaway market” reverses, you are not locked into inferior prices.
- Time. Trades in all calendar months. However, there can be limitations on which
options trade further out in time.
- Size. Allows for a more precise hedge size related to your desired protection.
- Protection. Different strike prices can enable you to protect prices at different levels.
DISADVANTAGES
Higher cost:
Premium paid is an upfront cost and requires an initial cash outlay.
Wasting asset:
Much like an insurance policy, option contracts expire at a specific date in the future.
Under most circumstances, their price (premium) tends to decline over time.
Efficiency:
Lower trading volume in some contracts may compromise efficiency.
Volatility:
More volatile product prices typically raise premium. We, as brokers, can help you determine
the
appropriate instrument to use.
It is important to remember that both futures and options involve a cash outlay or investment:
Futures needs a cash balance in your margin account to “finance” the hedge and may require further
cash outlays to meet margin calls.
Options are a direct purchase out of your cash balance and are paid for once and upfront.
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