Commodity Option Pricing: A Practitioner's Guide

3 Precious Metals

We start with precious metals, not because these are the area in commodity derivatives with the greatest trade volume (in fact oil takes that distinction), but because they are the simplest to introduce to readers who may have previously encountered either equity or foreign exchange (FX) derivatives. As such, these metals provide a natural introduction to commodities. In fact, until the collapse of the Bretton Woods agreement on 15 August 1971, all currencies were pegged to the US dollar, which in turn was convertible into gold at a fixed price of (approximately) $35 per (troy) ounce. Gold was basically a currency, as all currencies were linked to gold on the gold standard, a parity relationship which commenced with the British pound in 1717, thanks to a proclamation made by Isaac Newton in his role as Master of the Royal Mint.

While this is no longer true, gold, silver and the other precious metals (platinum, palladium and rhodium) still share many of the features of currencies. They are a durable store of value, and they can be used as commodity money.¹ Base metals such as copper might be used in coinage, but copper is an industrial metal first and foremost – see Chapter 4. Conversely, in addition to their role as investment vehicles, the precious metals all have their own industrial applications, as discussed in Section 3.3. However, the overall price levels of the precious metals is significantly higher than the base metals, as seen in Table 3.1 (prices ...