1. Lecture 20

2. Overview  A Futures Contract on an Option ◦ The underlying asset is not a stock ◦ The underlying asset is a futures contract  Call Futures Option ◦ Long Call = The right to long a futures contract ◦ Short Call = The obligation to short a futures contract  Put Futures Option ◦ Long Put = The right to short a futures contract ◦ Short Put = The obligation to long a futures contract

3. Option Specifications  Futures Options = FO  No delivery occurs  Commodities are Settled in Cash  Financials might take delivery  One option = one futures contract  Expiration ◦ Financial options  Same date as futures contract expiration ◦ Commodity Options  Expire the month prior to the futures contract expiration

4. Pricing  FO prices are listed in “units”  Each “Unit” has a $ value Example (Corn FO)  Underlying asset = 5,000 bushels of corn  1 unit = $6.25 (or 1/8 cents per bushel)  Dec300Call = 80 ◦ 80 x $6.25 = $500  The strike of 300 = $3.00 or 300 cents per bushel  CBOT lists details

5. Example (Soybean FO)  March soybean futures are selling for 575 cents per bushel  The underlying asset is one futures contract on 5,000 bushels of soybeans as listed on the CBOT  The value of one futures contract ◦ 5000 x $5.75 = $28,750  The unit value is $50 ◦ Determined 5000 x.01 = $50  The futures option price is quoted in Units (which are cents per bushel)  But the total price is $50 x cents

6. Example (Soybean FO) - continued  Mar525P = 5 (total cost = $50 x 5 = $250)  Mar550C = 35.50($1,775)  Mar600C = 8.25($ 412.50)  BE on March550C = 550 + 35.50 = 585.50

7. Units  Vary depending on the underlying asset  Each asset has a unique relationship among ◦ Asset price ◦ Futures Contract specs ◦ Option Basic Underlying Asset Categories  Commodity  Financial  Currency  others

8. Example - gold is quoted in $ per ounce Example - Sugar is quoted in cents per pound CBOT web site Pricing – Same as regular options. Black Scholes Binomial

9. FO Margin  Determined by volatility and risk of loss  Futures Options use unique margin accounting  SPAN= Standard Portfolio ANalysis of Risk Futures Options Uses Same as futures w/ flexibility Floors, ceilings, spreads, etc Employs all Option strategies Arbitrage (lots of mispricing)

10.  Class Brain storm