Investors can buy and sell natural gas options, which give them the right to buy or sell natural gas futures at a predetermined price. There are two types of options: call and put. Option buyers risk the premium paid, while sellers risk much more and must monitor the strike price. Natural gas options can be used to manage risk and increase flexibility.
Natural gas options are contracts that are bought and sold by investors and traded on stock exchanges, giving those investors the right to buy or sell natural gas futures at some point in the future. The asset underlying the option in this case is a natural gas futures contract, which is a contract in which a buyer obtains a specified amount of natural gas at a predetermined price. Buyers of natural gas options risk the premium paid for the option, but have the potential to make a significant profit if the price of natural gas moves in the desired direction before the expiration date of the contract. Option sellers risk much more than buyers and must closely monitor the strike price, which is the price at which the buyer can exercise the option contract.
As a form of energy, natural gas is often in high demand around the world due to its versatility and eco-friendly nature. Since this is the case, investors may make speculative purchases of natural gas futures to try to take advantage of an anticipated movement in the price of natural gas. Conversely, investors who wish to manage their risk and increase their flexibility may wish to purchase natural gas options.
There are two basic types of positions that an investor can hold in natural gas options. A call option is the option to buy a specified amount of natural gas futures at some point before the contract’s expiration date, while a put option gives the option holder the right to sell those futures. Call and put options can be bought or sold.
The amount of money paid for the contract is known as the premium, which is a much smaller amount than it would take to simply buy the underlying natural gas futures outright, allowing the option buyer less exposure. An option can be exercised as long as the current futures price reaches the strike price, which the option seller sets above the strike price for call options and below it for put options. If the current price never reaches the strike price before the expiration date, the option is worthless to the holder and the seller keeps the premium.
At any time before the expiration date, the option holder can sell his natural gas option contract, a practice known as closing out the option. It is important to note that the buyer of natural gas options is exposed only to the risk of the premium payment, whereas an option seller could lose significantly more if the current price of the underlying futures exceeds the strike price. For that reason, natural gas option sellers need to know where to set the strike price to minimize potential losses.
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