AGEC 420, Lec 401 Agec 420 HW #8: Regression – Fri. May 3 HW #9: Options in TradeSim – Wed, May 8 HW #10 - ungraded Exam 3: Friday, May 3 - Review session, May 2, 7pm, WA 41 Today Time value Option ‘Delta’ Position diagrams

AGEC 420, Lec 402 Checking Account Initial balance($10 * 85) $850 Wheat trade margin-$175 Corn trade margin- $125 Withdrawals-$300 Balance in checking$550

AGEC 420, Lec 403 Margin Account Deposits ($175, $125) $ Wheat trade (bot 2820, sold 2714)-$ Commissions/Fees- $25.12 Corn trade (bot 2292, at 2180) -$ Commissions/Fees- $25.11 Withdrawals -$ Balance in margin account $32.27

AGEC 420, Lec 404 $$$ Checking$ Margin$ –Balance$ (= $6.85/person)

AGEC 420, Lec 405 Markets CBOT: CME:

AGEC 420, Lec 406 Aug’02 Cattle

AGEC 420, Lec 407 Options - review Call option: –right to buy the underlying futures contract –at the specified strike price Put option: –right to sell the futures at the strike price Reading Purcell & Koontz – Ch 7 (pp ) CBOT Publication – on web page

AGEC 420, Lec 408 Put – Call Parity

AGEC 420, Lec 409 Put – Call Parity

AGEC 420, Lec 4010 Time value Reflects the market’s expectation for an option to have additional intrinsic value

Time value - example

Time value of Puts

AGEC 420, Lec 4013 Time value Reflects the market’s expectation for an option to have additional intrinsic value Options farther in- or out-of-the –money have lower time value (lower probability of additional intrinsic value) “Time decay”: the decline in time value as time passes: Time decay is more rapid as expiration approaches.

AGEC 420, Lec 4014 Option Delta Option prices don’t change as quickly as futures prices

AGEC 420, Lec 4015 Delta – example with Puts

AGEC 420, Lec 4016 Calculating Option Delta Futures price change = +3¾ Option ChangeDelta 230 Put- 1½1½ / 3¾ = Put- 2 1/8 2 1/8 / 3¾ = Put- 2 3/8 2 3/8 / 3¾ = Put- 2¾ 2¾ / 3¾ = 0.73

AGEC 420, Lec 4017 Delta – example with Calls

AGEC 420, Lec 4018 Values for Delta Delta = d option price / d futures price –varies between 0 and 1 OptionDelta (abs. value) Deep out-of-the-moneynear 0 Out-of-the money0 to 0.5 At-the-moneyapprox 0.5 In-the-money0.5 to 1.0 Deep in-the-moneynear 1.0

AGEC 420, Lec 4019 Position Diagrams Shows how net realized price (profit) changes as the futures price (at expiration) changes Vertical axis: net realized price (profit) Horizontal axis: futures price at expiration All examples are for Dec. Corn, assuming zero basis, and current futures at $2.50

Long Cash Net Price Futures Price Cash

Short 2.50 Net Profit Futures Price Futures

Long Cash + Short 2.50 Net Price Cash Futures Hedge Futures Hedge

AGEC 420, Lec 4023 Buy 2.50 Put for 10c Net Profit

AGEC 420, Lec 4024 Buy 2.50 Put for 10c Net Profit

AGEC 420, Lec 4025 Buy 2.50 Put for 10c Net Profit

AGEC 420, Lec 4026 Buy 2.50 Put for 10c Net Profit

AGEC 420, Lec 4027 Hedge with a 2.50 Put Net Price Put Cash Hedge

AGEC 420, Lec 4028 Price Floor For a short hedger buying put options: Price Floor = Strike price – Premium + Basis

AGEC 420, Lec 4029 Sell 2.50 Put for 10c Net Profit

AGEC 420, Lec 4030 Buy 2.50 Call for 10c Net Profit

AGEC 420, Lec 4031 Sell 2.50 Call for 10c Net Profit

AGEC 420, Lec 4032