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Trading Crude Oil Options

Updated on August 16, 2010

Trading Crude Oil Options

Traders who have an aversion to the volatility of the crude oil futures market may want to consider trading crude oil options (long options only, of course). Trading long calls limits your downside risk to a pre-defined amount, which many investors (including myself) find appealing. The whole business of futures and options trading is very risky anyway, so a more prudent investor would rather find ways to mitigate that risk as best as possible, and this can be done by using options as an trading vehicle instead of outright futures contracts. For those who may not know, a crude oil option gives you the right (but not the obligation) to purchase one crude oil futures contract (representing 1,000 barrels of crude) at a predetermined price (called the strike price) within a specified time frame. I’m assuming that most of you reading this hub already know this, but I wanted to just bring it back out in case there were any readers who weren’t fully aware of how the whole thing works. One thing to remember about trading options in general (not just crude options) is that options can afford a trader with some fantastic leverage. I have heard of (and personally experienced) story after story of someone buying a futures option for as little as $25.00 and then seeing that option explode in value when the price of the underlying futures contract shot up. I have one of my most famous stories where I bought an Orange Juice option for about $70.00 (forgot the exact amount), and within a week’s time, that option was worth over $2,000. The cool thing about options is although they are many times priced very low (the out-of-the-money options, that is), they have amazing potential to double, triple, quadruple, or even beyond based on any type of violent price movement in the underlying futures contract. When you buy crude oil options, if you choose a strike price that’s far out enough (meaning way above where the market is currently trading), you can pick them up for as little as 1 point ($10.00) apiece. Now I’m not going to give you a “pipe dream” scenario for these options, because many times they will expire worthless, but if you can catch the right option at the right time, just before a huge upswing in price (such as what happens in the more seasonal commodities like the Grains), you can really come out with an amazing return on investment, many times into the over-1,000% range.

Image courtesy of Google Images
Image courtesy of Google Images

Crude Oil Options Trading

And why is this possible? Well, remember—that option, although it may be cheap (and not all options are cheap, believe me—I’m just talking about the way-out-of-the-money options), it still represents one crude oil futures contract, which means 1,000 barrels of crude. If you think about it, if crude was trading for $80.00 a barrel today, that would mean that your $10.00 or $20.00 option could be controlling something worth $80,000. That’s some serious leverage. So then, if the price of crude futures moves up dramatically, your option is now worth WAY more than what you paid, because its movements are based on the “Big Daddy”—the actual futures contract, not the option itself. In the early 2000’s I remember a guy that used to show up in a lot of the trading forums that I frequent, and he kept talking about how he was buying crude call options for only $10.00 apiece—these were the calls that were WAYYYY out-of-the-money at the time. They had strike prices ranging from $40.00 to $50.00. Now at the time, crude was only trading for about $15.00 to $20.00 a barrel, so these options with the high strikes were mega-cheap. But then, crude started shooting to the moon, and I’m sure the value of his call options did the same. The funny thing is, after that major move, I don’t remember hearing from that guy again. He probably bought an island somewhere from his option profits. Anyway, didn’t mean to get off on that personal story, and I know that I didn’t even come close to giving you all of the extensive information that’s available out there about trading crude oil options, but I hope you have at least a better understanding about why they can be powerful financial instruments.

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    • profile image

      Rahul 

      3 years ago

      Go to your local library and boorrw a few books on the basics of investing. This will give you a good and free education.Be well educated before you try to enter the market. Novices usually lose money to the old professionals who have been doing trading for many years and have all the tricks of the trade at their control.

    • profile image

      Deo 

      3 years ago

      To invest in stckos all you need to do is:a) Be 18 (if under 18 then you need your parents to cosign)b) Talk to a stock broker to invest your moneyc) Have money to investAnd that's it, but that doesn't mean you will make money in the stock market. In this case I will assume you want to make money so there are extra steps that need to be taken.To make money from stckos you need to:a) Find a company that is either starting out or is in an economic slump -the stock prices should be low at that time -a good example is Ford way back during the economic crisis and stckos were under $2b) Research the company -who is the ceo? -does the ceo have experience with running a business? -how good is the companies business plan? -will the company thrive or go under? -these are some good questions to ask. When I bought my Ford stock, I knew the government wasn't going to let Ford go out of business and I researched and saw that the new ceo that was put in charge was put in situations like this before and saved companies from going out of business.c) Decide how much you will invest -how much can you afford to lose? -how strongly do you believe in the company?d) Talk to a stock broker -fees will be charged with investing in stckos -the lower the fees, the more you can investe) Watch the stock market and check your stock price every day -when you buy at a low price, you can sell at a high price for bigger profits -don't gamble for the jackpot! earlier this year, I could have sold my Ford stock for $18 share making a big profit considering i bought the stock at $2 a share and invested $1,000 for 500 shares. I was going to wait for it to hit $20 a share but it dropped quickly to $14 a share and now it is less than $10 because of the crisis in Europe and the amount of Ford cars sold there dropped.f) If everything was done correctly, talk to your stock broker to withdraw your money into your savings account. -this is where you make your moneyg) If things look like they are headed in a bad direction and your company might go out of business, talk to your stock broker quick and with draw your money before you lose all of it! -when things settle out at a lower price you can re-invest if you think the company might recover.Here is a good link on mutual funds

    • SteadyHubs profile imageAUTHOR

      SteadyHubs 

      5 years ago from Georgia, USA

      First of all, to everybody, I would like to apologize for the extremely long delay in my replies.

      @ TradeOptions: I wouldn't risk more than 1.5% to 2% of my total trading capital on any one trading idea. This is (of course) a very personal decision; some people risk up to 5% without batting an eye. I'm not that guy. Smart capital management would be to not risk more than 2% on any one trade. But, I am no investment/financial advisor, so don't take that as "gospel". Just my personal take. Entering criteria would be when volatility is low (if I'm buying) and when volatility is high (if I'm selling).

      @ ctrader: Not sure whatcha mean.

      @ MJ888: I wish I was MORE of a CL options seller, but my trading account is simply not big enough YET to be confident in selling those bad boys. It would be nice, though...Also, I think it's slightly inaccurate to say that 90% of option buyers lose money. I would suggest rather that 90% of people who buy out-of-the-money options lose money. There are plenty of option buyers making money--people who use vertical spreads, people who do volatility plays such as straddles & strangles, people who buy in-the-money options and ride a short-term trend, etc.

    • profile image

      MJ888 

      6 years ago

      Hahahahaha! The guy who wrote this article must be a CL options seller! Buying options for $10 is considered a "sucker bet."

      90% of option BUYERS lose money! I wonder who is making all the money that these buyers are losing? Oh yeah, options sellers! 10% of the people are making 90% of the money! I know which side I am on.

    • profile image

      ctrader77 

      6 years ago

      none

    • TradeOptions profile image

      TradeOptions 

      7 years ago from Houston

      How much capital (percentage wise) would you suggest to put on the line for each trade? What is your entering criteria? And how has this strategy worked for you in the long term?

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