Because of the volatile nature of the commodities markets, the purchase and granting of commodity options involve a high degree
of risk. Commodity option transactions are not suitable for many members of the public. Such transactions should be
entered into only by persons who have read and understood the disclosure statement and who understand the nature and
extent of their rights and obligations and of the risks involved in the option transactions
covered by the disclosure statement. The following is NOT a complete representation of the disclosure statement for options on futures (this is made available to persons wishing to open a futures and futures options trading account),
but it does identify some of the pertinent risks involved with options trading.
Underlying Instrument
Both the purchaser and grantor should know whether the particular option in which they contemplate trading is an option which, if exercised, results in the establishment of a futures contract (an "option on a futures contract") or results in the making or taking of delivery of the actual commodity underlying the option (an "option on a physical commodity"). Both the purchaser and grantor of an option on a physical commodity should be aware that, in certain cases, the delivery of the actual commodity underlying the option may not be required and that, if the option is exercised, the obligations of the purchaser and grantor will be settled in cash.
In the case of an option on a futures contract, both the purchaser and grantor of an option on a futures contract should
realize that the option, if exercised, will result in the establishment of a futures position. The buyer of a call option will be assigned a long position in the underlying futures if excercised, while the buyer of a put option will
be assigned a short position in the underlying futures if exercised. The
purchaser of an option should be aware that some option contracts provide for
only a limited period of time during which an option may be exercised.
Risk of Loss
The purchaser of a put or call option is subject to the risk of losing the
entire purchase price of the option, in addition to commissions paid. A person
should therefore not purchase a commodity option unless they are able to
sustain such a loss. In other words, money used to purchase options should be
risk capital.
While option purchasers pay the full premium up front and are not required to
pay additional margin, option grantors or sellers may be required to deposit
additional margin if the market moves against them (a market price rise in the
case of the call option grantor and a market price decline in the case of a put
option grantor). A person should not, therefore, grant a commodity option
unless they are able to meet such additional calls for margin and, in such
circumstances, to sustain a very large financial loss. In cases where it is
difficult to offset a losing option position on an exchange, the option grantor
will be subject to the full risk of their positions until the options expire.
Liquidity Concerns
Exchange trading mechanics are designed to provide for competitive execution and to make available to buyers and to sellers a continuous market in which an option once purchased can later be sold; and in which an option, once granted, can later be liquidated by an offsetting purchase. Although each exchange's trading system is designed to provide market liquidity for the options traded on that exchange, there can be no assurance that a liquid offset market on the exchange will exist for any particular option, or at any particular time, and for some options no offset market on that exchange may exist at all. In such an event, it may not be possible to effect offsetting transactions in particular options. Thus, to realize any profit, a holder will have to exercise their option and have to assume all risks and to comply with margin requirements for the underlying futures contracts or, in the event of an option on a physical commodity, incur the costs and risks of holding the physical good. A grantor could not terminate their obligation until the option expired or they were assigned an exercise notice. You may exercise your option but be unable to liquidate your resulting futures position because of daily price limits or lack of liquidity in the futures market.
Price Limits
The individual should be aware that an option may not be subject to daily price
fluctuation limits even if the underlying futures has such limits and, as a
result, normal pricing relationships between options and the underlying futures
may not exist. Also, futures positions assigned as a result of an expiring
option may not be capable of being offset if the underlying futures is at a
price limit.
Deep Out-of-the-Money Options
A person contemplating the purchase of a deep out-of-the-money option (that is,
an option having a strike price significantly above, in the case of a call, or
significantly below, in the case of a put, the current price of the underlying
futures contract) should be aware that the chance of such an option becoming
profitable is ordinarily remote. On the other hand, a potential grantor of an
out-of-the-money option should be aware that such options normally provide
small premiums while exposing the grantor to all of the potential losses of an
option sale.
Other Risks
The grantor of a call option who does not have a long position in the
underlying futures contract, that is, the case of a naked sale or short, is
subject to risk of loss should the price of the underlying futures be higher
than the strike price of the option, and this loss may exceed the premium
received for the initial sale of the call option. The grantor of a call option
who has a long position in the underlying futures, that is, the case of a
covered sale or short, is subject to the risk of decline in price of the
underlying futures, less the premium received for granting the call option. In
exchange for the premium received, the call option grantor gives up all of the
potential gain resulting from an increase in the price of the underlying
futures above the strike price of the option.
The grantor of a put option who does not have a short position in the
underlying futures contract, that is, the case of a naked sale or short, is
subject to risk of loss should the price of the underlying futures be below the
strike price of the option, and this loss may exceed the premium received for
the initial sale of the put option. The grantor of a put option who has a short
position in the underlying futures, that is, the case of a covered sale or
short, is subject to the risk of a rise in price of the underlying futures,
less the premium received for granting the put option. In exchange for the
premium received, the put option grantor gives up all of the potential gain
resulting from a decrease in the price of the underlying futures below the
strike price of the option.
