What are Gold Options and How to Buy Gold Options?
Investing in the stock market, commodity, or security and doing well at it is not that easy. Many people have lost millions of dollars in the stock market because they didn’t know better.
The majority of these investors belong to the “over-zealous” cohort who invest by the hordes, hoping to become the next Warren Buffet, not aware of the kind of effort, resilience, and patience that goes into every investment move Mr. Buffett makes.
Talking about challenges, if the equity market represents the beginner investing tier, derivatives would undoubtedly be a level or two higher—thanks to the complexity, risks, and kind of speculation attached to them. Derivatives investing necessitates a relatively extensive understanding of financial securities than all other kinds of investing.
There are different forms of derivatives, or an options contract can be based on any inherently valuable asset. One of the more popular assets considered for an options arrangement is gold. Gold options, alongside gold futures, are lucrative investment opportunities. However, they aren’t for casual investors or people who don’t care to learn more.
In this article, we’ll talk about:
- Gold options and their two major types
- How to invest in gold options
- Things to be wary of when dabbling with gold options and more
The goal here is not to make you a gold options expert but to provide a solid concept overview. Read on to learn more.
Table of Contents
What is a Gold Option?
An option contract is a formal agreement between two parties, facilitating a future transaction based on an underlying asset at a predetermined price. The derivative’s value is based on the underlying security. Gold options are options contracts that use either gold futures or physical gold as that “underlying asset”. “Gold option” is the derivative.
A gold options contract’s terms—like any options agreement with another underlying asset—would have the quantity, delivery date, expiration date, strike price, and other details are ascertained beforehand.
The delivery date is the last date by which the seller of the option must transfer the physical gold or gold futures to the buyer/holder.
The expiration date signifies the last valid date of the contract. The concerned parties decide on their ultimate course of action before or on the expiration date—which could be exercising the option or letting the agreement expire.
The strike price is the price at which the concerned parties agree to execute the transaction. The set price is predetermined or an already agreed-upon price.
If you’re bearish or bullish about the gold market or would like to benefit from the fluctuations in the price of gold monetarily, a gold options agreement provides you the avenues to do that. However, you must pay a premium to the retail or online broker to get that privilege or service.
Gold options trade on several derivatives exchanges worldwide. In America, the CME COMEX exchange lists gold options. COMEX is the primary market for trading options and futures contracts entailing gold, copper, silver, and other metals. COMEX, however, only deals with gold futures and isn’t directly involved with physical gold transactions.
Read more: Physical Gold vs. Paper Gold
How are gold options different from gold futures?
Gold options are pretty similar in structure to a gold futures contract. They have expiration dates, predetermined prices, etc. The only and perhaps the biggest differentiator is gold futures doesn’t give the holder the option to exercise or not execute the contract.
A gold futures buyer is obligated to buy or sell the underlying gold futures outright, irrespective of the market price of gold at the time of agreement expiration.
The Two Sides of a Gold Option
A gold option could be a call or put option.
Call Gold Option
The call option affords the buyer or holder the right to buy the gold asset at the strike price on a future date. However, the call buyer is under no obligation to execute their right.
If the price of gold decreases or the strike price is higher than the spot price of gold on the expiration date, the buyer can choose to forfeit their call option. But if the gold price goes up, they can exercise the option and buy the gold at the lower price.
The buyer then has the option of holding on to the gold to achieve specific investment goals or outright selling it in the open market, earning a decent profit.
Whether the buyer purchases the underlying gold at the strike price or lets the contract expire worthless, the option seller has no choice but to conform.
Put Gold Option
The put option grants the buyer the right to sell their gold at the strike price. If gold prices fall before or when the option expires, the buyer can exercise the right to sell the gold at a higher price.
If the price of gold rises or the spot or current gold price is higher than the strike price at the time of expiration, the put option buyer can choose not to exercise their option and sell the gold outside of the contract to another buyer. Like gold call options, the put option seller has no choice but to play ball with the buyer.
Buying Gold Options and Rolling with It
People buy gold options to profit from their clairvoyance about falling or rising gold prices. The decision to purchase the option is predicated on their beliefs that prices of gold would change in the foreseeable future. If you believe you could be a part of this, open a gold option account.
Setting Up a Gold Options Account
To purchase gold options, you would require a margin brokerage account that lets you trade options and futures.
A margin account is different from your regular trading account as the broker or dealer lends you cash to buy securities. The account serves as the collateral. The larger sum, courtesy of the loan, lets you bet big than you would have otherwise been able to with your own money. The loan provision is not available with a traditional account. You’ll need to have cash in your regular account to start trading.
To open a margin brokerage account, your online broker could require you to sign a few more documents than usual to confirm you’re on board aware of the investing risk attached to derivatives trading.
Once the account is set up, you may start trading gold options or futures. You can directly purchase and sell those gold option contracts using the platform provided. For the services offered, the brokerage will charge you a commission based on the gold options trades you’ve carried out in a given period.
TD Ameritrade and Interactive Brokers are the two best online brokers for gold futures and options trading. Interactive Brokers charges a $0.65 fee for options trades agreement, alongside a minimum $1.00 commission. A single contract trade price is $1.00, and the cost of trading 50 contracts is $32.50. The charges apply to gold options and also other types of option agreements.
The above fees are pretty typical or charged by other players in the industry too.
Gold Options Trading Warrants Vigilance
Since there’s a specific time frame within which you must spring into action or exercise your calls and puts, you must remain active or continually monitor gold price movements during the entirety of a gold options agreement.
Doing so would boost your chances of successfully rolling over, selling, or exercising your put or call options. Otherwise, the gold options contract may expire worthless, which is always possible.
Moreover, since options arrangement entails a certain level of debt or leverage by default, it’s crucial not to overuse or get overboard with trading gold options, particularly when experiencing significant losses. If you do not exercise caution when facing a string of losses, it won’t take too long before you are left burdened by a mountain of financial loss.
Not All Brokerages Offer Gold Options
Kindly note, not all brokers allow trading on the gold options market. Some firms may permit stocks and ETFs options trading but not gold options. You may, however, trade gold mining stocks or gold ETFs using the provision. Check with your brokerage firm if you are eligible for the same, and if not, learn about the various requirements to gain direct access to gold options markets.
Read more: Is Gold Worth More Than Money?
If you’re new to stock markets or investing in general, it’s recommended you do not trade gold options or any form of options arrangement right at the onset of your investing journey.
Even seasoned investors may have a hard time wrapping their heads around the inner workings of an options arrangement. Someone with only basic knowledge about stock exchanges, as ar result, is likely to fail with futures and options.
If, however, you are pretty confident of your investing skills and would like to invest in a precious commodity like gold, a gold option could be a suitable gold investing channel for you. If you play your cards well, you stand to make a good chunk of money. However, as stated earlier, tread slow and watch every step you take.
Again, do not take this article as your guide to becoming wealthy investing in gold options or the gold market in general. That never was our intended goal. Use the information shared above as the base on which you could build greater knowledge about gold options and gold markets.
For a simpler, more accessible way to invest in gold, look at a gold IRA or consider investing in gold bullion. A gold IRA facilitates buying physical gold without having to take possession of it or deal with its storage requirements. Click on our complete guide to investing in gold IRAs to know more.