4 Tips for Beginning to Use Commodities Options

Commodities options contracts allow you to pick a set time in the future when you can buy or trade a commodity, based on a price you determine today. Options were originally created as a way to diversify risk in the commodities market, offering buyers the chance to speculate and sellers the change to hedge their goods. Now, the options market has multiple players, including individual investors, who capitalize on correctly predicting changes in prices. 

#1 Be Prepared to Lose

The first rule of all commodities investing, but particularly with options, is you have to be prepared to lose money. If you are good at what you do, just like a good poker player, you will have many successes in options trading. However, you are still gambling real money, and you will find unforeseen events at times compromise your ability to make a profit on a deal. If the weather turns, a crop spoils or a delivery date is missed, despite your best calculations, the price of the commodity you are trading could be much different from what you expected. Even with a product like oil, which is not contingent on the weather, political conflicts can change the price sharply. 

#2 Stick with What you Know

The first time you step into a casino, you would not go to the black jack table if your specialty is poker. The same thing applies in the commodity market. There is real expertise in each area, and you should capitalize on yours instead of engaging in bets on markets you are unfamiliar with. If you are a cattle farmer, enter the beef market; if you are a gold miner, choose to enter the gold market. If you are an investor with little experience in any market, start simple with the less volatile hard commodity markets instead of stepping into the very unpredictable soft markets.

#3 Avoid Trends

The commodity market, if it operated efficiently, would price every good at its actual value to the consumer. Unfortunately, analysis shows the market is not at all efficient. It is skewed by investors; namely, large capitalization investors, like hedge funds, can be distorting the price of a good well beyond its actual value. Instead of betting on a trend, choose your options based on actual analysis. Do not trust that the price of a good indicates its value. 

#4 Minimize Income and Capital Gains

If you are successful with your commodities trades, you will be earning an impressive income on the market. This income may even translate into capital gains in your portfolio. You have the option of reinvesting the income you earn and deferring taxes, spreading out your taxable income over a large period of time. This is a good strategy if you have an extremely successful year. You can place some of your gains back into the market. Then, in a year when you experience losses, you can liquidate your gains, and better minimize the amount of money you will pay in taxes over the years. This is an entirely legal strategy for tax minimization.

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