Understanding Commodity Futures & Options: Lots, Expiry & Strikes

By now, the market itself should feel a little less unfamiliar. You know where commodity contracts trade in India, how a broker gives you access and why searching for Gold can bring up more than one instrument.

The next step is understanding what those instruments actually are.

Suppose you think Gold may rise. You could buy Gold Futures, buy a Call, sell a Put or use another position that reflects that view.

Each route begins with the same opinion on Gold, but the trade itself can behave very differently.

A futures contract is a standardised agreement to buy or sell a specified quantity of a commodity at a price agreed in the market for a particular contract month. The exchange defines the quantity, expiry and settlement terms, so everyone trading that contract is dealing with the same specifications.

One of the first things to understand is that the futures price does not necessarily match the price of the commodity today.

Spot Price vs Futures Price

The spot price is the price of the commodity in the physical market today. A futures price belongs to a contract that expires at a later date.

That difference in timing matters. Suppose Gold is available at a certain price today, but the futures contract expires three months from now. Someone carrying that Gold until then may have to bear financing, storage and insurance costs, and those costs can get reflected in the futures price.

Conditions in the physical market are important as well. If supply is tight in the near term, buyers may be willing to pay more for immediate availability than for a contract expiring several months later.

So spot and futures prices are connected, but they do not have to be identical. The same applies across futures contracts. October Gold Futures and December Gold Futures are separate contracts representing Gold at different points in time, which is why they can trade at different prices.

As expiry approaches, the futures price generally moves closer to the spot price because the time separating the two is disappearing.

Once that relationship is clear, the next step is identifying exactly which futures contract you are looking at.

Reading A Futures Contract

A Gold futures contract may appear as:

GOLD 05 OCT FUT

That is why searching for Gold can show several futures contracts at once. GOLD 05 OCT FUT and GOLD 05 DEC FUT are different contracts with different expiries and their own traded prices.

Expiry schedules can also vary across commodities, so the contract specification matters more than assuming every market follows the same pattern.

The contract specification also tells you something else that matters: how much of the commodity one contract actually represents.

Lot Size

Commodity futures trade in standardised lot sizes.

Think of a lot as the minimum tradable quantity defined for that futures contract. You are not buying “one unit” of Gold or Crude Oil. When you trade one lot, you are taking exposure to the entire quantity represented by that contract.

For example, if a Gold contract represents a fixed quantity of Gold, buying one lot means your position moves with the price of that entire quantity.

Different commodities have different lot sizes, so the size of the position can change significantly from one contract to another. That is why lot size matters when we later calculate contract value, margin and actual exposure in Chapter 8.

Before we get there, there is one more part of the futures contract to understand: what happens when it reaches expiry.

Expiry And Settlement

A futures contract is linked to a specific expiry date, after which that particular contract ends.

What happens at expiry depends on how the contract is settled. Some commodity futures are physically settled, which means the contract can move into a delivery process under exchange rules. Others are cash settled, where the financial difference is settled without the commodity itself changing hands.

For most traders, settlement may never become relevant because the position is closed before expiry. But the settlement terms still matter. If a position is held into the expiry process, those rules determine what happens next.

So when reading a futures contract, four things are worth checking: the commodity, the expiry, the lot size and the settlement method.

Together, they tell you what that particular futures contract actually represents. Options work differently, and that is where we go next.

Options provide another way to express a view on a commodity, but they work differently from futures.

In a futures contract, both sides take on an obligation. With an option, the buyer pays a premium for a right, while the seller receives that premium and takes on the corresponding obligation.

A Call Option gives the buyer the right to take a long position in the underlying futures contract at the strike price, while a Put Option gives the buyer the right to take a short position.

Every option also has a strike price, which defines the price at which that right applies, and an expiry, after which the option contract ends.

So an option brings together a few basic pieces:

Underlying + Call or Put + Strike + Premium + Expiry

The buyer and seller are taking very different positions. The buyer pays the premium to acquire the right, while the seller receives the premium in return for taking on the obligation. We will get into the risk and capital implications of that difference later.

The option's premium is also influenced by what happens to the underlying futures contract. As that futures price moves relative to the strike, the value of the option can change as well.

What Sits Under A Commodity Option?

There is one important feature of commodity options to understand before going further.

A commodity option is linked to a specific commodity futures contract, rather than directly to the physical commodity.

So a Gold option is not simply an option on “Gold” in the abstract. It is linked to a particular Gold futures contract with its own expiry.

If the option is exercised, it can result in a position in that underlying futures contract. That futures position then follows the expiry and settlement rules we have just covered.

Commodity options can also expire before the futures contract underneath them, which leaves time for any resulting futures position to be managed before the futures contract itself expires.

Once that relationship is clear, terms such as ITM, ATM and OTM become much easier to understand.

ITM, ATM And OTM

Options are commonly described as in-the-money, at-the-money or out-of-the-money. These terms describe where the strike price sits relative to the price of the underlying futures contract.

For a Call Option:

• Strike below the underlying futures price → ITM
• Strike around the underlying futures price → ATM
• Strike above the underlying futures price → OTM

For a Put Option, the relationship works in the opposite direction.

These labels do not tell you whether an option is a good trade. They simply describe the relationship between the strike and the underlying futures price at that point in time.

Now that you know how both futures and options work, the practical question is: which one should you choose for a particular market view?

There are several ways to express a view through futures and options. For a simple comparison, take two ways of expressing a bullish view on Gold: buying Gold Futures and buying a Gold Call Option.

With futures, the position responds more directly to movements in the futures price. With a Call Option, the buyer pays a premium for a different payoff structure. While the position remains a long option, the buyer's loss is limited to the premium paid.

The two trades may begin with the same view on Gold, but their risk, payoff, capital requirement and behaviour before expiry can be very different. Neither is automatically the better choice.

The instrument therefore comes after the market view. Once you know what you want to trade and how you want to express the view, the next question is practical: how much capital will that position actually require?

That takes us to Chapter 8: How Much Capital Do You Need to Trade Commodities?

• Futures and options provide different ways to express a commodity view, but the position, risk and payoff can differ significantly.
• A futures contract represents a standardised quantity of a commodity for a specific expiry, and different expiries can trade at different prices.
• Commodity futures trade in lots, and the contract's expiry and settlement method determine what happens if the position is carried further.
• A commodity option has a Call or Put, strike price, premium and expiry, while ITM, ATM and OTM describe the strike relative to the underlying futures price.
• Commodity options are linked to a specific futures contract, so an option carried into exercise can result in a futures position.