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Crude Oil Options Explained
Crude Oil options are option contracts in which the underlying asset is a crude oil futures contract. The holder of a crude oil option possesses the right (but not the obligation) to assume a long position (in the case of a call option) or a short position (in the case of a put option) in the underlying crude oil futures at the strike price. This right will cease to exist when the option expire after market close on expiration date.
Crude Oil Option Exchanges
Crude Oil option contracts are available for trading at New York Mercantile Exchange (NYMEX).
NYMEX Light Sweet Crude Oil option prices are quoted in dollars and cents per barrel and their underlying futures are traded in lots of 1000 barrels (42000 gallons) of crude oil.
NYMEX Brent Crude Oil options are traded in contract sizes of 1000 barrels (42000 gallons) and their prices are quoted in dollars and cents per barrel.
| Exchange & Product Name | Underlying Contract Size | Exercise Style | Option Price Quotes |
| NYMEX Light Sweet Crude Oil Options | 1000 barrel (Full Contract Specs) | American | Calls | Puts |
| NYMEX Brent Crude Oil Options | 1000 barrel (Full Contract Specs) | American | Calls | Puts |
Call and Put Options
Options are divided into two classes - calls and puts. Crude Oil call options are purchased by traders who are bullish about crude oil prices. Traders who believe that crude oil prices will fall can buy crude oil put options instead.
Buying calls or puts is not the only way to trade options. Option selling is a popular strategy used by many professional option traders. More complex option trading strategies, also known as spreads, can also be constructed by simultaneously buying and selling options.
Crude Oil Options vs. Crude Oil Futures
Compared to the outright purchase of the underlying crude oil futures, crude oil options offer advantages such as additional leverage as well as the ability to limit potential losses. However, they are also wasting assets that has the potential to expire worthless.Additional Leverage
Compared to taking a position on the underlying crude oil futures outright, the buyer of a crude oil option gains additional leverage since the premium payable is typically lower than the margin requirement needed to open a position in the underlying crude oil futures.Limit Potential Losses
As crude oil options only grant the right but not the obligation to assume the underlying crude oil futures position, potential losses are limited to only the premium paid to purchase the option.
Flexibility
Using options alone, or in combination with futures, a wide range of strategies can be implemented to cater to specific risk profile, investment time horizon, cost consideration and outlook on underlying volatility.
Time Decay
Options have a limited lifespan and are subjected to the effects of time decay. The value of a crude oil option, specifically the time value, gets eroded away as time passes. However, since trading is a zero sum game, time decay can be turned into an ally if one choose to be a seller of options instead of buying them.
Related Articles
- Crude Oil Futures Basics
- Buying Crude Oil Futures to Profit from a Rise in Crude Oil Prices
- Selling Crude Oil Futures to Profit from a Fall in Crude Oil Prices
- Crude Oil Call Option Trading Basics
- Crude Oil Put Option Trading Basics
- Hedging Against Rising Crude Oil Prices with Crude Oil Futures
- Hedging Against Falling Crude Oil Prices with Crude Oil Futures
How to Start Trading Crude Oil Options
To buy or sell crude oil options, you need to open a trading account with a broker that handles futures options trades. Most online options brokerages out there only deal with stock options and only a few such as optionsXpress lets you trade BOTH stock and futures options. optionsXpress also provide a virtual trading platform where beginners can try out futures and options trading in real market conditions without using real money.
