Options Terms Commodity Marketing Activity Chapter #5

What is an Option? zThe RIGHT but not the OBLIGATION to buy or sell futures contracts at a specified price and time zOptions specify: yright to buy or sell a futures contract ythe commodity and contract month yprice zLife of option: expires 1-2 weeks before delivery date

What is an Option? zPrice is called the strike price. yThis doesnt change zPremium is paid to the seller of the option ycan be high or low based on the strike price zTwo kinds of options yPut yCall

What is a PUT Option? zThe right to sell a futures contract at a specific price (strike price) zDecember corn 260 put is an option that gives you the right to sell a Dec. corn futures contract for $2.60 zthe same put with a strike price of $2.50 would have a lower premium zBuy Put Options to lock in a minimum price for the sale of a commodity zYou can benefit if price rises

Put Options zAs a buyer of a PUT Option, you can: yexercise the option (exchange it for the futures contract) yoffset the option (sell it back) ylet the option expire

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

What is a CALL Option? zThe right to BUY a futures contract at a specific price zEx: 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 zLock in a maximum price zcan exercise option, let expire, or offset zIf prices rise = sell and get a premium, if prices fall, let expire and take advantage of low cash market price

Compare Put and Call zRight to sell future zSomeone who PUTS commodity on market, SELLS zSet min. price, can benefit from price rise zcan sell the put zdo nothing, let expire zexchange for futures contract at strike price z Right to buy future z Someone who CALLS a commodity from the market, BUYS z Set max. price, can benefit from price fall z can sell the call z do nothing, let expire, and buy on cash market z exchange for futures contract at strike price

Option Premiums zAmount you pay when you buy an option zPremium varies with strike prices zDetermined by traders in open outcry zFactors affecting premiums: yrelationship of strike price to current futures price for the same contract ytime remaining before options expire

What is Intrinsic Value? zRelationship between strike price and current futures price zPut Option, Intrinsic Value = Strike Price - Futures Price zIt 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 zIV = 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