x

Commodity Put Option

What is a Commodity Put Option?

A Commodity Put Option is a contract that grants the Producer the right but not the obligation to sell a specified quantity of a commodity to the Consumer at a fixed price before a stated future date.

Objective

The purpose of a Commodity Put Option is to establish a minimum income from a future sale of a commodity. It limits the downside risk while maintaining the ability to trade at a higher spot rate if market prices rise.

How does it work?

An oil Company knows they will have produced 500 barrels of oil in a year’s time. They do not want to pay for storage any longer than necessary and do not want to sell the oil for less than $105 a barrel. They buy a put option with a strike price of $105. If the price falls below this level they will exercise the option and have the right to sell oil to the Buyer at $105 per barrel. But if the price is above the strike they can allow the option to expire and sell their barrels at the market rate.

Advantages
  • Provides the Producer with a minimum income
  • Gives the Producer the opportunity to benefit from higher prices
Disadvantages
  • The Producer will incur a premium cost, usually paid up-front
  • If prices rise above the strike rate during the tenor of the option, the Producer may feel they received no value

Commodity Put Option example:

 

Recent insights

Views
South African Rating Relief
Lionel Kruger Weekly bulletin October 2018
Reports & Whitepapers
Private Equity Deal Digest Q3 2018
Benoit Duhil de Benaze Private Equity October 2018

Contact us

If you need hedging or debt advice or would like to speak to the team about helping your business please get in touch.