Fundamentals of Commodity Options on Futures Avner Wolf cademic research in commodity options is not as extensive as research on A stock options, partly because commodity exchange options are not traded in the US. Moreover, even research on London options which have traded for some time is far from exhaustive. The purpose of this article is to introduce commodity options on futures. Specifically, it will examine the option pricing formula in Black (1976) and show how to calculate the theoretical values of options on futures. These values will serve as a benchmark in evaluating the premiums of options on futures. Although options on agricultural commodities were introduced in the U.S. by traders in the mid-1800s, options trading has undergone several periods of suspended operations, especially in the 20th century. Trading in commodity options ceased in 1920 because of a prohibitive tax imposed by the Futures Trading Act. which was declared unconstitutional by the Supreme Court in 1926. Options trading halted again in 1933 because of a three-year drop in grain prices. In 1936 the Congressional Commodity Act banned trading of options on regulated commodities. Until 1974 there were no restrictions on trading options on unregulated domestic commodities, mainly metals, and London options were traded in the U.S. In 1974, the Commodity Futures Trading Commission (CFTC) obtained the right to regulate trading of commodity options through an amendment to the Commodity Exchange Act. However, this right did not extend to options on commodities proscribed by the 1936 Act.2 In November 1975, part A of the options regulations was imposed by CFTC.3 These regulations dealt with London options and dealer options.
During the early 1970s there were cases of fraud in the commodity options industry. In 1978, when part B of the options regulations was near completion, Lloyd Carr and Company, an options dealer that violated many of the CFTC The opinions expressed in this paper are those of the author and not necessarily of COMEX.
'For the history of the development of option trading see Hoag (1978), pp. 3-8.
'For example, options on futures contracts on agricultural commodities are still prohibited. 31n part A of the regulations each option dealer was required to make a full disclosure to his customers of the risks associated with a purchase of the option and the option's markup. In addition, the dealer had to segregate the customer's funds.