Are commodity options used to hedge losses in commodities like they are in stocks?

Question

Are commodity options used to hedge losses in commodities like they are in stocks?

Answer 1

Yes, a commodity producer or user can hedge with options on commodity futures. However, commodity hedging is usually done with futures. That is, a farmer growing corn would hedge by selling corn futures (he is long the basis). A manufacturer of corn flakes would hedge by buying corn futures (he is short the basis). The hedge reduces the risk of price volatility.



The farmer could hedge by buying puts and the manufacturer by buying calls. Options if not in-the-money upon expiration are worthless and the premium paid is lost, however they allow the buyer to take advantage of favorable price moves. Futures lock in pricing with little variation (just change in basis) and there is no premium.



Options are like insurance and futures are like completing the transaction in advance.

Answer 2

Yes they are. That is the primary purpose of the commodities market. Businesses buy commodity options to protect the price of goods in contracts they enter. A miller contracts to deliver 40 tons of flour in six months based on today's price of wheat, and to make sure the contract results in a profit, he buy wheat futures at today's price and takes deliver in time to start milling the wheat. Whether the price of wheat increases or decreases when he needs it, he is protected by the futures contract.



Of course, many speculators also operate in the market creating liquidity and a large number of buyers and sellers, making the market quite efficient. Speculators close their positions before delivery of the commodity, so many buy and sell orders get canceled.

Answer 3

Yes they are. They are universally used by large agricultural orgs and mining orgs as a cost of doing business. When I was an undergrad doing econ, I called Impala in South Africa and had about a fifteen minute talk with the CEO on the subject.

Answer 4

would you use commodity options to hedge your losses in vegas? I dont think so. Dumb question