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Options Strategies. Commodity Marketing Activity Chapter #6. Option Premiums. EX: corn put option premium = $.20 Corn contract = 5,000 bu Buyer of a corn put pays $1,000 ($.20 x 5,000) to the seller of the put

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options strategies

Options Strategies

Commodity Marketing Activity

Chapter #6

option premiums
Option Premiums
  • EX: corn put option premium = $.20
  • Corn contract = 5,000 bu
  • Buyer of a corn put pays $1,000 ($.20 x 5,000) to the seller of the put
  • If the option is worthless at the time he is ready to sell his corn, let it expire, and lose $1,000
  • If the value is above $0, he can offset it by selling it back and MAY gain a profit
  • No Margin Deposit is required
option premiums1
Option Premiums
  • The Seller takes a greater risk
  • If Seller wants to OFFSET his put, he must buy the same futures contract
    • margin deposit required
    • to guarantee against any loss
  • Producer must pay a commission to broker to trade options
hog producer example
Hog Producer Example
  • In June, you expect to have 525 hogs ready for market in November
  • Local buyer offers $44.50/cwt, your target is higher
  • You want protection if prices fall, but want to take advantage if prices rise
  • First Step = set your target price
target price
Target Price

Strike Price $52.00 $50.00 $46.00

Prem. Cost $ 4.50 $ 2.75 $ .75

Expect Basis $-2.00$-2.00$-2.00

Target Price $45.50 $45.25 $43.25

  • You want to establish a minimum price of $45/cwt
  • You will need 3 options to protect 400 hogs
  • You have the $3,300 ($2.75 x 400 per option) so you buy the $50 Dec. put option
prices fall
Prices Fall
  • In November, futures fall to $45, local cash price is $43 (basis = -$2)
  • Dec 50 hog put option premium = $5
  • You sell 3 Dec 50 puts and get the $5 ($2.25/cwt profit)
  • You sell hogs locally for $43
  • Total income = $43 + $2.25 = $45.25
  • $2,700 gain over cash market alone
prices rise
Prices Rise
  • Futures rise to $49
  • Sell Dec 50 put for premium of $1 (loss of $1.75)
  • Cash Price = $47
  • Total Income = $47 - $1.75 = 45.25
prices rise1
Prices Rise
  • Futures price = $52
  • Put Option is worthless
  • Let Option expire, lose $2.75
  • Sell hogs for $50
  • Total income = $50 - $2.75 = $47.25
storage stragegy
Storage Stragegy
  • November, you have 35,000 bu of corn
  • Cash price = $2.20
  • Cash Forward Contract (July) = $2.60
  • Storage cost is $ .28/bu
  • Want to lock in min. of $2.60 and benefit of price rises
  • Expected Basis = -10 cents
  • Calculate Target Price
target price1
Target Price

Strike Price $3.00 $2.90 $2.80

Prem. Cost $ .22 $ .15 $ .10

Exp. Basis $- .10$- .10$- .10

Target Price $2.68 $2.65 $2.60

Cur. Cash Pr. $2.20$2.20$2.20

Storage Gain $ .48 $ .45 $ .40

action
Action
  • You will need 7 option contracts
  • Cost of Premiums will be:
    • $.22 x 35,000 = $7,700 ($3 strike) or
    • $.15 x 35,000 = $5,250 ($2.90 strike)
  • Based on cash flow, you choose $2.90 strike price
prices rise2
Prices Rise
  • In July, Futures price = $3.10, and Cash Price = $3.00
  • July 290 put is worthless, let it expire, lose $.15/bu
  • Sell corn for $3 in cash market
  • Total income = $3.00 - $.15 = $2.85 vs $2.30 if Forward Contract
prices fall1
Prices Fall
  • Futures price = $2.35, cash = $2.25
  • Sell July Corn 290 puts at higher premium ($.55) for profit of $.40/bu
  • Total income = $2.25 + $.40 = $2.65
purchasing strategy
Purchasing Strategy
  • As a purchaser of feeder cattle, you buy CALL options to protect yourself against price increases while leaving yourself open to profit from price decreases
  • In July, you planning to buy 240 feeder cattle in December
  • Establish Target Price
target price2
Target Price

Strike Price $64.00 $62.00 $60.00

Prem. Cost $ 2.55 $ 3.90 $ 5.70

Expect Basis $+1.00$+1.00 $+1.00

Target Price $67.55 $66.90 $66.70

  • Target max. purchase price = $67/cwt, rule out 64 call option
  • Total premium for 4 calls:
    • $3.90 x 440 cwt x 4 = $6,864 (62 call) or
    • $5.70 x 440 cwt x 4 = $10,032 (60 call)
prices fall2
Prices Fall
  • Buy 4 January feeder cattle 62 calls at $3.90/cwt
  • In December, futures price = $58, cash price = $59
  • Jan. Calls are worthless, let expire, lose $6,864
  • Buy feeder cattle at $59/cwt
  • Total cost = $59 + $3.90 = $62.90
prices rise3
Prices Rise
  • Futures price = $70, cash price = $71
  • Sell option for $8 ($4.10 profit)
  • Buy cattle for $71
  • Total cost = $71 - $4.10 = $66.90