What is a Gold Option
A gold option is an option, but not the obligation, to buy or sell gold bullion at a future date at a set price. In this option, a gold futures contract would be the underlying asset securing the investment. The option agreement terms list details such as the delivery date, quantity and strike price, which are all predetermined.
BREAKING DOWN Gold Option
A gold option is a derivative with gold as the underlying asset. Options are complicated and require time to understand, so may not be for all investor types. Also, it is possible to experience significant losses.
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 which are put options and call options. However, there are four types of participants as both the call and put can be either bought or sold.
A gold option is similar 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.
- Call gold options gives 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 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 contracts demands delivery up to the expiration date.
- Put gold options gives 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. 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.
The Condition for Exercising Gold Options
As with other types of options, an investor would only want to exercise his 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. If gold is 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.
(To learn more on trading options see Options Basics: What are Options?)