Econ 337, Spring 2013 ECON 337: Agricultural Marketing Chad Hart Associate Professor Lee Schulz Assistant Professor

Econ 337, Spring 2013 Options  What are options?  An option is the right, but not the obligation, to buy or sell an item at a predetermined price within a specific time period.  Options on futures are the right to buy or sell a specific futures contract.  Option buyers pay a price (premium) for the rights contained in the option.

Econ 337, Spring 2013 Setting a Floor Price  Short hedger  Buy put option  Floor Price = Strike Price + Basis – Premium – Commission  At maturity  If futures < strike, then Net Price = Floor Price  If futures > strike, then Net Price = Cash – Premium – Commission

Econ 337, Spring 2013 Put Option Graph Put Option June 2013 Live $128 Premium = $3.275 Commission = $0.01 Strike Price = $128 Put Option Return = Max(0, Strike Price – Futures Price) – Premium – Commission

Econ 337, Spring 2013 Setting a Ceiling Price  Long hedger  Buy call option  Ceiling Price = Strike Price + Basis + Premium + Commission  At maturity  If futures < strike, then Net Price = Cash + Premium + Commission  If futures > strike, then Net Price = Ceiling Price

Econ 337, Spring 2013 Call Option Graph Call Option Dec $6 Premium = $0.50 Commission = $0.01 Strike Price = $6 Call Option Return = Max(0, Futures Price – Strike Price) – Premium – Commission

Econ 337, Spring 2013 Option Premiums  Can be divided into two sections:  Intrinsic value  What is the option worth today?  Time value  How much time is left on the option? Intrinsic value depends on the futures price and the strike price of the option. Time value depends on the length of time in the option and the price volatility in the market.

Econ 337, Spring 2013 Example DayFutures Price Option Premium Intrinsic Value Time Value 1$12.00$0.60$0.00$0.60 2$12.20$0.56$0.00$0.56 3$11.70$0.83$0.30$0.53 4$11.55$0.95$0.45$0.50 5$11.90$0.67$0.10$0.57 Start with an soy put $12.00 per bushel

Econ 337, Spring 2013 Combination Strategies  Option fence  Buy put and sell call  Put spread  Buy At-the-money put and sell Out-of-the- money put

Econ 337, Spring 2013 Option Returns in Fence Buy Put Option May 2013 $6.50 Premium = $ Sell Call Option May 2013 $7.50 Premium = $

Econ 337, Spring 2013 Fence for Speculator Buy Put Option May 2013 $6.50 Premium = $ Sell Call Option May 2013 $7.50 Premium = $

Econ 337, Spring 2013 Fence for Hedger Buy Put Option May 2013 $6.50 Premium = $ Sell Call Option May 2013 $7.50 Premium = $

Econ 337, Spring 2013 Option Returns in Spread Buy Put Option May 2013 $7.50 Premium = $0.53 Sell Put Option May 2013 $6.50 Premium = $

Econ 337, Spring 2013 Spread for Speculator Buy Put Option May 2013 $7.50 Premium = $0.53 Sell Put Option May 2013 $6.50 Premium = $

Econ 337, Spring 2013 Spread for Hedger Buy Put Option May 2013 $7.50 Premium = $0.53 Sell Put Option May 2013 $6.50 Premium = $

Econ 337, Spring 2013 Combination Strategies  Butterfly  Condor  Straddle  Strangle  These positions can be flipped

Econ 337, Spring 2013 Condor Buy $6.50 Premium = $ Sell $5.50 Premium = $ Buy $7.50 Premium = $ Sell $8.50 Premium = $0.0125

Econ 337, Spring 2013 Condor for Hedger

Econ 337, Spring 2013 The 4 Basic Graphs for Options  Buy a put  Buy a call  Sell a put  Sell a call

Econ 337, Spring 2013 Class web site: Spring2013/ Lab in Heady 68.