The concept of optionality has been around at least as long as commercial trade between ports and nations and today is often used to provide shipowners and traders with a means of hedging that is closely related to physical positions.
An option is a contract that gives the buyer the right, but not the obligation, to buy (a ‘call’ option) or alternatively sell (a ‘put’ option) the underlying instrument (the FFA market) at a specified price in the future.
The buyer of a call option will benefit from a rise in FFA prices. Conversely, the seller of a call option will benefit from stable or falling FFA prices. The buyer of a put option will benefit from falling FFA prices. Conversely, a seller will benefit from stable or rising FFA prices.
Options can be used for speculating or hedging and as with any market, there are risks associated with speculating. The advantage of buying an option is that the maximum loss is limited to the premium paid.
Hedging can be thought of as an insurance policy. For example, an owner who wants to protect against a fall in freight prices while preserving the ability to benefit from a rise in prices would buy a put option.
The buyer of an option knows the maximum loss at the time of the trade. A seller knows the maximum profit. Therefore, a seller has an element of risk associated with the transaction and is most likely to sell an option only at a price that will compensate for that risk.