Managing risk in volatile commodity markets is a critical concern for end users—such as producers, manufacturers, or consumers of raw materials—who are exposed to price fluctuations. Two relatively simple and effective long option strategies they often use are:

  1. Long Call Options

  2. Vertical Bull Call Spreads

Here’s how each works and how they help manage risk:

1. Long Call Options

Purpose: Protect against rising prices (especially useful for consumers of commodities).

How It Works:

  • The end user buys a call option, giving them the right (but not the obligation) to buy the commodity at a predetermined strike price before expiration.

  • If the market price rises above the strike price, the call gains value, offsetting the increased cost of the physical commodity.

Risk Management Benefits:

  • Unlimited Upside Protection: Gains increase as the commodity price rises.

  • Limited Downside Risk: The maximum loss is the premium paid for the option.

  • Flexibility: The user is not obligated to exercise the option if prices fall or remain stable.

Example:

A food manufacturer buys a call option on wheat with a strike price of $600 per bushel. If wheat spikes to $700, the option offsets the higher cost. If wheat stays below $600, the only loss is the premium.

2. Vertical Bull Call Spread

Purpose: Reduce the cost of protection while still benefiting from moderate price increases.

How It Works:

  • The end user buys a call option at a lower strike price and simultaneously sells a call option at a higher strike price (same expiration).

  • This creates a “spread” that profits when the commodity price rises, but caps the maximum gain.

Risk Management Benefits:

  • Lower Cost: The premium received from the short call helps offset the cost of the long call.

  • Defined Risk and Reward: Both maximum loss and gain are known upfront.

  • Efficient for Moderate Bullish Views: Ideal when the user expects prices to rise, but not skyrocket.

Example:

A fuel-dependent company expects oil prices to rise moderately. It buys a $70 call and sells a $90 call. If oil rises to $85, the spread gains value, helping offset higher fuel costs. If oil stays below $70, the loss is limited to the net premium paid.

Strategic Considerations

Strategy Best For Max Loss Max Gain Ideal Market View
Long Call Consumers hedging rising costs Premium paid Unlimited Strong bullish
Bull Call Spread Cost-sensitive hedgers Net premium paid Difference in strikes – net premium Moderately bullish

Final Thoughts

  • These strategies are especially useful for budgeting and planning, as they provide price ceilings without forcing physical delivery.

  • They are non-linear hedges, meaning they behave differently than futures or forwards, which can be advantageous in volatile markets.

  • End users should consider volatility, time to expiration, and strike selection to tailor the strategy to their risk tolerance and market outlook.

Would you like to explore how these strategies compare to futures or how producers might use put options instead?