1. Agricultural Marketing
ECON 337:
Agricultural Marketing
Chad Hart
Assistant Professor 1

2. 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.

3. Option Types Two types of options: Puts and Calls
A put option contains the right to sell a futures contract.
A call option contains the right to buy a futures contract.
Puts and calls are not opposite positions in the same market. They do not offset each other. They are different markets.

4. Put Option
The Buyer pays the premium and has the right, but not the obligation, to sell a futures contract at the strike price.
The Seller receives the premium and is obligated to buy a futures contract at the strike price if the Buyer uses their right.

5. Call Option
The Buyer pays a premium and has the right, but not the obligation, to buy a futures contract at the strike price.
The Seller receives the premium but is obligated to sell a futures contract at the strike price if the Buyer uses their right.

6. Options as Price Insurance
The person wanting price protection (the buyer) pays the option premium.
If damage occurs (price moves in the wrong direction), the buyer is reimbursed for damages.
The seller keeps the premium, but must pay for damages.

7. Options as Price Insurance
The option buyer has unlimited upside and limited downside risk.
If prices moves in their favor, the option buyer can take full advantage.
If prices moves against them, the option seller compensates them.
The option seller has limited upside and unlimited downside risk.
The seller gets the option premium.

8. Option Issues and Choices
The option may or may not have value at the end
The right to buy corn futures at $4.00 per bushel has no value if the market is below $4.00.
The buyer can choose to offset, exercise, or let the option expire.
The seller can only offset the option or wait for the buyer to choose.

9. Strike Prices
The predetermined prices for the trade of the futures in the options
They set the level of price insurance
Range of strike prices determined by the futures exchange

10. Options Premiums Determined by trading in the marketplace
Different premiums
For puts and calls
For each contract month
For each strike price
Depends on five variables
Strike price
Price of underlying futures contract
Volatility of underlying futures
Time to maturity
Interest rate

11. Option References In-the-money At-the-money Out-of-the-money
If the option expired today, it would have value
Put: futures price below strike price
Call: futures price above strike price
At-the-money
Options with strike prices nearest the futures price
Out-of-the-money
If the option expired today, it would have no value
Put: futures price above strike price
Call: futures price below strike price

12. Options Premiums Mar. 2012 Soy Futures $11.87 per bushel In-the-money
Out-of-the-money
Source: CBOT, 3/20/09

13. 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

14. Put Option Graph Put Option Nov. 2012 Soybean @ $11.80
Strike Price = $11.80
Put Option Return =
Max(0, Strike Price – Futures Price) – Premium – Commission
Premium = $0.89
Commission = $0.01

15. Put Option Graph Put Option Nov. 2012 Soybean @ $11.80 Premium = $0.89
Net = Cash Price + Put Option Return

16. Short Hedge Graph Sold Nov. 2012 Soy Corn @ $11.83
Net = Cash Price + Futures Return

17. Comparison

18. Out-of-the-Money Put
Put Option Nov $10.80
Premium = $0.44

19. In-the-Money Put
Put Option Nov $12.80
Premium = $1.53

20. Comparison

21. 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

22. Call Option Graph Call Option Nov. 2012 Soybean @ $11.80
Strike Price = $11.80
Call Option Return =
Max(0, Futures Price – Strike Price) – Premium – Commission
Premium = $0.93
Commission = $0.01

23. Call Option Graph Call Option Nov. 2012 Soy Corn @ $11.80
Premium = $0.93
Net = Cash Price – Call Option Return

24. Long Hedge Graph Bought Nov. 2012 Soy @ $11.83
Net = Cash Price – Futures Return

25. Comparison

26. Summary on Options Buyer Seller Buying puts Buying calls
Pays premium, has limited risk and unlimited potential
Seller
Receives premium, has limited potential and unlimited risk
Buying puts
Establish minimum prices
Buying calls
Establish maximum prices

27. Class web site:
Have a great weekend!