What Is a Gold Option?
A gold call option would give the holder the right, but not the obligation, to buy bullion at a future date at a set price, while a put option would grant the holder the right to sell it at a predetermined price level. The option agreement terms will list details such as the delivery date, quantity, and strike price, which are all predetermined.
- Gold options are options contracts that utilize either physical gold or gold futures as their underlying instrument.
- Call options on gold give the contract holder the right to buy the metal at a pre-set price before it expires.
- Put options work in the opposite way, granting the right to sell at a predetermined price level.
- Gold options trading in the U.S. are listed on the CME COMEX and use gold futures, which represent 100 troy oz. of gold, as the underlying asset.
Understanding Gold Options
The gold options contract is an agreement between two parties to facilitate a potential transaction on a quantity of gold. The contract lists a preset price, known as the strike price, and an expiration date.
There are two primary types of options contracts: put options and call options. However, there are four types of participants as both the call and put can be either bought or sold.
Types of Gold Options
- Call gold options: Give the holder the right, not the obligation, to buy a specific amount of gold at the strike price until the expiration date. A call option becomes more valuable as the price of gold increases because they locked in a buy at a lower price. When you buy the call, you have the right, but not the obligation, to purchase the gold. If, on the other hand, you sell the call, you do not have a choice and must sell the gold at the predetermined price when the person holding the opposite side of the contract demands delivery up to the expiration date.
- Put gold options: Give the owner the right, but not the obligation, to sell a specific amount of gold at the strike price until the expiration date. A put option becomes more valuable as the price of gold decreases because they locked in a sell at a higher price. If you buy the put, you have the right, but not the obligation, to sell the gold. Meanwhile, when you sell a put, you do not have a choice and must purchase the gold at the predetermined price from the person holding the opposite side of the contract.
If neither the holder of the call or put options exercise their rights, the contract will expire as worthless.
Gold Options vs. Gold Future Contracts
A gold option is similar in some ways to a gold futures contract in that the price, the expiration date, and the dollar amount are preset for both. However, with a futures contract, there is an obligation to uphold the agreement and either buy or sell the agreed-upon quantity of gold at the agreed-upon price.
Conversely, an investor who holds a gold option has the right, but not the obligation, to claim the relevant position, which will depend on if they hold the call option or the put option.
Gold Options Contract Specifications
COMEX is the primary futures and options market for trading metals such as gold, silver, copper, and aluminum. Formerly known as the Commodity Exchange Inc., COMEX merged with the New York Mercantile Exchange (NYMEX) in 1994 and became the division responsible for metals trading. Today, COMEX—and the NYMEX more broadly—operates as a division of the Chicago Mercantile Exchange (CME).
COMEX gold options actually use gold futures, rather than physical gold directly, and so are cash-settled. These gold futures have a contract size of 100 troy ounces each and require physical delivery if not closed out.
It is possible to experience significant losses with gold options.
The Condition for Exercising Gold Options
As with other types of options, an investor would only want to exercise their gold option rights if the market conditions make it beneficial.
If at the time the buyer can use, or exercise, their option, gold is trading at a price significantly higher than the strike price, the investor would benefit by exercising their option. The investor could then turn around and quickly sell that gold on the open market for a quick profit.
Should, on the other hand, gold be trading at or near the strike price, the investor may break even or perhaps even take a loss, once their initial cost to purchase the option is factored in.