Gold Options Explained



Gold OptionsGold options are option contracts in which the underlying asset is not Gold Bullion but a gold futures contract. You can trade gold options in the same way as you would a traditional securities option, so both calls and puts are available.

As usual with options you’re under no obligation to buy the futures contract at the strike price. If you don’t wish to exercise the option you can simply let it expire.

Where Are Gold Options Traded?

Gold option contracts are traded on both the New York Mercantile Exchange (NYMEX) and the Tokyo Commodity Exchange (TOCOM).

NYMEX Gold option prices are quoted in dollars and cents per ounce and their underlying futures are traded in lots of 100 troy ounces of gold.

TOCOM Gold options are traded in contract sizes of 1000 grams (32.15 troy ounces) and their prices are quoted in yen per gram.

Call and Put Options

Gold Options are available in both calls and puts, calls should be bought buy traders who think that the overall trend is bullish. Traders who believe that the overall trend is bearish should buy put options instead.

Calls and puts can also be combined together by simultaneously buying and selling options to create what’s called a spread.

How to Trade Gold Options

Let’s say that a near-month NYMEX Gold futures contract is trading at $114.00 per ounce. A NYMEX Gold put option (bearish) with the same expiration and a strike price of $100.00 is being priced at $1.30/oz. Since each underlying NYMEX Gold futures contract represents 100 troy ounces of gold, the options premium you need to pay to own the put option is $130.00.

Upon expiration, the price of the underlying gold futures has fallen by 15% and is now trading at $96.90 per ounce. At this price, your put option is now in the money.

If you exercise your put option, you get to assume a short position in the underlying gold futures market at a strike price of $100.00. That means you get to sell 100 ounces of gold at $100.00/oz upon delivery.

If you wanted to take profit from the trade you’d need to enter an offsetting long futures position for one contract of the underlying gold futures at the market price of $96.90 per ounce, resulting in a net profit of $3.10/oz. Since each NYMEX Gold put option covers 100/oz of gold, your gross profit from the long put position is $310.00. After deducting the initial option premium of $130.00 your net profit from the long put option will be $180.00.

In reality you wouldn’t wait to exercise the put option to realize your profit. You could simply close out the position early by selling the put back to the market.

The above example doesn’t include any commissions that you’d have to pay your broker to execute the options trade. These commissions vary from broker to broker but usually amount to around $10 to $20 per trade.

Gold Options vs. Gold Futures

Looking at the above example you might be wondering if it would be easier to just trade the underlying Gold futures and forget about options altogether. But options have significant advantages over futures, including additional leverage and lower risk.

For instance if you were to buy gold options you’d gain additional leverage over the equivalent futures contract, since the premium payable is typically much lower than the margin required to open a position in the underlying gold futures market.

And since you’re under no obligation to buy the futures contract upon expiry, your maximum potential loss is limited to the price you paid to purchase the option. If you purchased the futures outright your potential loss would be unlimited.

Conclusion

As you can see if you’re already used to trading options, Gold options are fairly straight forward. But if you’re new to options, you might be feeling a little confused. The best thing for you to do is sign-up for an account with optionsXpress; once approved they’ll give you a virtual $25,000 to play with.

Use what you’ve learned here and carry out a few test trades. It won’t take you long before you’re up to speed. You’ll also find a whole lot more training resources and tutorials to help take your trading to the next level.




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