How call options work in energy trading

The constant volatility in energy markets highlights the importance of protecting budgets against price increases. Call options provide a solution, and while the concept might seem complex, it’s fairly straightforward at its core.

The building blocks

Let’s break down the essential elements of a call option, using oil trading as an example:

• Strike price: This is the maximum price you’ll pay. If you buy a call option with a $80 per barrel strike price, you have the right to buy oil at $80 per barrel, regardless of how high market prices go.
• Premium: This is the cost of the call option. For example, if the premium is $1 per barrel, that’s your maximum potential loss. Think of it like an insurance premium; it’s paid upfront and non-refundable.
• Expiry date: Call options have a set expiration date. You might buy a three-month call option, giving you the right to buy at your strike price at any point within those three months.

How it works in practice

Suppose you’re trading oil, and current prices are $75 per barrel, but you’re concerned they may rise. You decide to buy a call option with the following details:

• Strike price: $80 per barrel
• Premium: $1 per barrel
• Duration: Three months

If prices jump to $90 per barrel, your call option lets you buy at $80 per barrel, saving you from the higher market price. If prices instead fall to $70 per barrel, you can let the option expire and purchase at the lower market price.

When traders use call options

Call options become particularly valuable in scenarios such as:

• Anticipated market volatility
• Periods of potential price increases
• Protecting against unexpected cost increases
• As a part of diversified trading strategies

The unique aspects of energy call options

Energy call options differ from those in other markets due to several unique characteristics:

• They can be settled either physically or financially.
• They are often structured around specific delivery periods.
• They can be tailored to specific trading hubs or regions.
• They are adaptable to varying volume requirements, fitting a range of energy consumption needs.

Our team of experts is available to guide you through the nuances of energy call options and tailor a strategy that suits your trading requirements. Get in touch to explore how call options could enhance your approach to energy market volatility.