Options Terms: Commodity Marketing Activity Chapter #5

Options Terms

Commodity Marketing Activity Chapter #5

What is an Option? ❚ The RIGHT but not the OBLIGATION to buy or sell futures contracts at a specified price and time ❚ Options specify: ❙ right to buy or sell a futures contract ❙ the commodity and contract month ❙ price

❚ Life of option: expires 1-2 weeks before delivery date

What is an Option? ❚ Price is called the strike price. ❙ This doesn’t change

❚ Premium is paid to the seller of the option ❙ can be high or low based on the strike price

❚ Two kinds of options ❙ Put ❙ Call

What is a PU T Option? ❚ The right to sell a futures contract at a specific price (strike price) ❚ December corn 260 put is an option that gives you the right to sell a Dec. corn futures contract for $2.60 ❚ the same put with a strike price of $2.50 would have a lower premium ❚ Buy Put Options to lock in a minimum price for the sale of a commodity ❚ You can benefit if price rises

Put Options ❚ As a buyer of a PUT Option, you can: ❙ exercise the option (exchange it for the futures contract) ❙ offset the option (sell it back) ❙ let the option expire

Put Option example ❚ You buy a Dec. hog 46 put ❚ =strike price of $46/cwt ❚ If futures price falls below $46, you can sell the put and receive a premium ❚ If price rises above $46, you can let the option expire, and take advantage of the higher price ❚ Few producers exercise the option (offset or expire)

What is a CALL Option? ❚ The right to BUY a futures contract at a specific price ❚ Ex: Dec. corn 230 call is an option that grants you the right to buy a Dec. corn futures contract at a strike price of $2.30 ❚ Lock in a maximum price ❚ can exercise option, let expire, or offset ❚ If prices rise = sell and get a premium, if prices fall, let expire and take advantage of low cash market price

Compare Put and Call ❚ Right to sell future ❚ Someone who PUTS commodity on market, SELLS ❚ Set min. price, can benefit from price rise ❚ can sell the put ❚ do nothing, let expire ❚ exchange for futures

❚ Right to buy future ❚ Someone who CALLS a commodity from the market, BUYS ❚ Set max. price, can benefit from price fall ❚ can sell the call ❚ do nothing, let expire, and buy on cash market ❚ exchange for futures

Option Premiums ❚ Amount you pay when you buy an option ❚ Premium varies with strike prices ❚ Determined by traders in open outcry ❚ Factors affecting premiums: ❙ relationship of strike price to current futures price for the same contract ❙ time remaining before options expire

What is Intrinsic Value? ❚ Relationship between strike price and current futures price ❚ Put Option, Intrinsic Value = Strike Price - Futures Price ❚ It can NEVER be negative Strike Price $3.00 $3.00 $3.00 Futures Price $2.65 $3.00 $3.20 Intrinsic Val $ .35 $ .00 $ .00

Intrinsic Value of a Call ❚ IV = Futures Price - Strike Price Futures Price $2.65 $2.40 $2.30 Strike Price $2.40 $2.40 $2.40 Intrinsic Value $ .25 $ .00 $ .00