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Natural gas options are contracts that are bought and sold by investors and traded on stock exchanges, giving those investors the right to buy or sell natural gas futures at some point in the future. The asset underlying the option in this case is a natural gas futures contract, which is a contract in which a buyer gets a specified quantity of natural gas for a predetermined price. Buyers of natural gas options risk the premium paid for the option but have the potential to make a significant profit if the price of natural gas moves in the desired direction before the contract's expiration date. Sellers of options risk much more than buyers and must closely control the strike price, which is the price at which the options contract may be exercised by the buyer.
As a form of energy, natural gas is usually in high demand throughout the world due to its versatility and environmentally friendly nature. Since this is the case, investors can make speculative purchases of natural gas futures to try to take advantage of an anticipated move in the price of natural gas. By contrast, investors who wish to manage their risk and increase their flexibility might wish instead to purchase natural gas options.
There are two basic types of positions that an investor may hold with natural gas options. A call option is the option to buy a specified amount of natural gas futures at some point before the expiration date of the contract, while a put option gives the option holder the right to sell those futures. Both call and put options may be bought or sold.
The amount of money paid for the contract is known as the premium, which is a much smaller amount than it would take to simply buy the underlying natural gas futures outright, thus allowing the option buyer to be less exposed. An option may be exercised whenever the current price of the futures reaches the strike price, which is set by the option seller above the strike price for call options and below it for put options. If the current price never reaches the strike price before the expiration date, then the option is worthless to the holder and the seller pockets the premium.
At any point before the expiration date, the option holder may sell his natural gas option contract, a practice known as closing out the option. It is important to note that the buyer of natural gas options is exposed to only the risk of the premium payment, while an option seller could lose a great deal more if the current price of the underlying futures moves way beyond the strike price. For that reason, sellers of natural gas options should be aware of where the strike price should be set to minimize potential losses.