Options Terms

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Options Terms

• Commodity Marketing Activity
• Chapter 5

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What is an Option?

• The RIGHT but not the OBLIGATION to buy or sell
  futures contracts at a specified price and time
• Options specify
• right to buy or sell a futures contract
• the commodity and contract month
• price
• Life of option expires 1-2 weeks before delivery
  date

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What is an Option?

• Price is called the strike price.
• This doesnt change
• Premium is paid to the seller of the option
• can be high or low based on the strike price
• Two kinds of options
• Put
• Call

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What is a PUT Option?

• The right to sell a futures contract at a
  specific price (strike price)
• December corn 260 put is an option that gives you
  the right to sell a Dec. corn futures contract
  for 2.60
• the same put with a strike price of 2.50 would
  have a lower premium
• Buy Put Options to lock in a minimum price for
  the sale of a commodity
• You can benefit if price rises

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Put Options

• As a buyer of a PUT Option, you can
• exercise the option (exchange it for the futures
  contract)
• offset the option (sell it back)
• let the option expire

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Put Option example

• You buy a Dec. hog 46 put
• strike price of 46/cwt
• If futures price falls below 46, you can sell
  the put and receive a premium
• If price rises above 46, you can let the option
  expire, and take advantage of the higher price
• Few producers exercise the option (offset or
  expire)

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What is a CALL Option?

• The right to BUY a futures contract at a specific
  price
• Ex 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
• Lock in a maximum price
• can exercise option, let expire, or offset
• If prices rise sell and get a premium, if
  prices fall, let expire and take advantage of low
  cash market price

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Compare Put and Call

• Right to sell future
• Someone who PUTS commodity on market, SELLS
• Set min. price, can benefit from price rise
• can sell the put
• do nothing, let expire
• exchange for futures contract at strike price

• Right to buy future
• Someone who CALLS a commodity from the market,
  BUYS
• Set max. price, can benefit from price fall
• can sell the call
• do nothing, let expire, and buy on cash market
• exchange for futures contract at strike price

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Option Premiums

• Amount you pay when you buy an option
• Premium varies with strike prices
• Determined by traders in open outcry
• Factors affecting premiums
• relationship of strike price to current futures
  price for the same contract
• time remaining before options expire

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What is Intrinsic Value?

• Relationship between strike price and current
  futures price
• Put Option, Intrinsic Value Strike Price -
  Futures Price
• It 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

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Intrinsic Value of a Call

• IV 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

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