Many clients have been asking me how to use options to protect long commodity positions, especially given the recent strength in the U.S. dollar and the pullback in the energy markets. We have seen market conditions that carried through all spring and summer suddenly turn, and trends shifted. Many traders without appropriate risk-management strategies saw profits erode on their long- term positions.

First, I recommend anyone with a long-term position have an option plan in place upon entering a trade, to protect your position. You can do many things, but what I recommend as a simple strategy is to either buy puts against your long position, or sell near-month calls, which does limit your upside potential on your futures position, but offers the opportunity to collect premium that can offset losses.

For example, if you are considering buying one front-month gold futures contract at $850 an ounce, figure out what you are willing to risk. Of course, you can place a stop, but often with this approach, you can have the right idea on direction of the market in the longer-term, but can get stopped out if the market is volatile in the shorter-term and you aren’t able to catch the move.

One alternative to using a stop is to buy a put. Continuing the gold example, the $820 strike price would be $30 away from your entry point. The cost of the option will depend on time value and the option’s intrinsic value, but it will protect the downside somewhat in the short-term if the market moves against your futures position, while allowing you to maintain that position if you feel the market will eventually rebound. 

Another way to manage risk is by selling call options against your futures position. For the same scenario, you are long from $850. You can sell the front-month $900 call for $500, (the cost is just used as an example, and is not necessarily reflective of the current market).  It will cap any potential gain on the future position at $900, but you will stand to collect the premium you sold the option for if gold never reaches $900 by the time your options expire. I recommend if you do this, use the front-month contract with not more than 30 days to go before your short call expires. This is not a true hedge, as it will only bring in $500 in premium, and losses on your futures could be greater. Keep in mind also, selling options involves the potential for unlimited risk. I recommend working with a professional if you aren’t experienced in such strategies. However, selling options can be an effective risk-management strategy, allowing you a way to offset losses while still maintaining your core futures position.

I do not believe gold’s days are necessarily over, given current energy market conditions and geopolitical factors on the horizon (i.e. Iran and Russia). With these conditions in place, I prefer using the put strategy I mentioned above, versus selling the calls.  If you have any further questions on this topic or would like help formulating a trading strategy to suit your unique needs, please feel free to contact me. 

Bob Haberkorn is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at 888-801-9302 or via email at bhaberkorn@lind-waldock.com.

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

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