Option Symbol

1. Option Symbol Understanding Options Symbols:Options quotes follow a pattern that enables you to easily construct and interpret symbols once that formula is understood. The basic parts of an option symbol are:Root symbol + Month code + Strike price code

2. Option Symbol A root symbol is not the same as the ticker symbol. Please refer to the option chain for that ticker to find the corresponding root. In conjunction with the option root symbol, you can utilize the tables below to assist you in creating or deciphering options symbols. Note: Yahoo also requires the ".X" suffix to identify the security type as an option

3. Expiration Month Code

4. Strike Price Code

5. Strike Price Code

6. Example For QQQ: QQQDH For AOL: AOLJK For IBM: IBMDT For MSFT: MSQDM

7. Options vs Futures Hedging Both can be used to protect against adverse price movement. Option hedging allows price movements in favor of the cash position to be captured. But futures hedging prevents you from receiving the benefits of favorable price movements

8. Importance of Basis in Option Hedging Basis is factor that remains important to hedgers even though they are using options rather than futures. Basis with options that are exercised is very easy to calculate.

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10. Selecting an Option For a hedger with options, the choices are many: Usually at least seven to fifteen different strike prices and premiums are available. The hedger can select very cheap out-of-the money options to very expensive in-the-money options. Which should a hedger choose?

11. Selecting an Option The decision will vary among hedgers and will change for a given hedger as conditions change, Several factors must be considered before selecting the options: Two most important factors are: Financial requirements Price Protections

12. Selecting an Option Financial Requirements: Option buying vs selling Price Protection: When selecting an option, the hedger can choose various levels of price protections. Hedger may want to choose a price level that covers all costs and provide a profit margins or choose a price levels that covers only a portion of costs.

13. Selecting an Option All costs plus a profit margin All costs Variable costs Fixed costs Cash costs Some percentage of costs

14. Practical Hedging Considerations

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16. Types of Practical problems In this chapter, we will discuss about some practical problems that hedgers face. We have divided these problems into two sections. Cross hedging Selective hedging

17. Cross Hedging The major problem in hedging any commodity is that the cash position and the futures position do not match exactly. Most of the times, futures contracts do not fit cash position of the hedger. This nonalignment can take several forms Different commodities: The futures contract is for one commodity and cash position or need is for another similar commodity. Example: Futures contract is sold for #2 yellow corn and the cash position is sorghum or alfalfa.

18. Different forms of nonalignment Different grades/standards/maturities: The futures is for only a specific grade or standard and/or maturity and the cash position is for another. Example: Futures contract is specified as #2 yellow corn and cash position is #3 corn

19. Different forms of nonalignment Different time periods: The cash position must be entered or liquidated on a time schedule other than the specified futures delivery periods. Example: Cash position is expected to be liquidated on Feb 15 and the futures is for a March delivery period. Different Quantities: The futures contract standardized size units do not match the cash position amount. Example: Futures calls for 40,000 pounds of fed cattle and the cash position is 30,000 pounds.

20. Any one or combination of all four of these conditions will cause problems for the hedger. The first three of these considerations can be appropriately called cross hedging problems. Cross hedging simply the process of hedging when the cash position and the futures position do not match exactly. The fourth condition, one of difference in quantity, is also a cross hedging problem but is more correctly called the problem of over and under-hedging. The difference in quantity will also require a different calculation of net hedge price to reflect over- and under-hedging.

21. Ways to handle these problems Different commodities: The issue ranges from closely related and similar commodities to those that are seemingly unrelated. Is hedging possible for a rancher who has all heifers and the feeder cattle futures contract calls for steers? Hedging a cash alfalfa position with a corn futures Hedging #2 grain sorghum contract with a corn futures.

22. Handling different commodities problem Although each of these products are closely related, they differ considerably in physical makeup and market structure. The real issue is not so much that the cash and futures commodities are closely related but that their price movements are closely related. The real issue in hedging and cross hedging is price movements and also the basis risk. To compare price movements, simple graphical analysis can provide useful analysis and also correlation analysis.

23. Handling different commodities problem Hedging and cross hedging should only be attempted if the price movements are similar and basis risk is acceptable to the hedger. Do your homework before cross hedging. Study the historical relationship between the cash price and the proposed futures price to determine whether they are correlated. Check the correlation for the time period that the hedge will be placed.

24. Problem of Different Grades/Standards/Maturities A cash position may be composed of #3 yellow corn and the future position is #2 yellow corn. The process is to study the historical price relationships between cash and futures prices to determine the degree of correlations.

25. Problem of Different Time Hedges and cross hedges should, for beginning hedger at least, be placed using a futures contract month that expires as close to the actual final cash position as possible, but not before. If placed before the final cash transaction, then the hedge will have to be lifted before final transaction, thus the hedger is no longer hedged and the cash is in a speculative position.

26. Problem of Different Time When the cash position is not known, then a process of hedging with the nearby, or one contract month away from the nearby, and then rolling the hedge is a common and accepted hedging practice.

27. Problem of Different Quantity As indicated earlier, one of the most troublesome aspects of hedging is the issue of matching the size of the cash position and future position. Example: Cash position may be 63,000 pounds of fed cattle but the live cattle futures is for 40,000 pounds at CBOT and 20,000 pounds at Mid America Exchange. Can you hedge and if so, how much? Because of the inexact amounts of most cash positions, almost 100 percent of all hedges are either over-hedged or under-hedged.

28. Problem of Different Quantity An over-hedged occurs when the futures quantity exceeds the cash quantity. An under-hedged occurs when the cash quantity exceeds the futures quantity. The problem can be handled by trying to match quantities as closely as possible.

31. Problem of Different Quantity The easiest way to handle the problem of quantity is to use a combination of regular size futures and mini contracts to reach a futures position as close as possible to the cash position.

32. Minimum Risk Hedge An alternative to trying to match quantities as close as possible is to consider a minimum risk hedge. A minimum risk hedge is a hedge that tries to equate dollar movement rather than quantity amount. The basic idea is that hedger wants price protection from hedging, not profit. True price protection occurs when the cash and futures move exactly the same and there is no basis change.

33. Minimum Risk Hedge Therefore, some other process must be used to achieve dollar equivalency rather than matching quantities. One way to achieve this is to mismatch quantities based on historical information.

34. Selective Hedging A na�ve hedge is a hedge that is placed when a cash position is assumed and a hedge is maintained until the cash position is liquidated. Once you are comfortable with hedging, you may want to find ways to be hedged when the cash market prices are moving against you and not to be hedged when cash prices are moving in your favor.

35. Selective Hedging Selective hedging has been shown to be effective in increasing net hedged prices.

37. Selective Hedging To be effective, selective hedging must be used in conjunction with forecasting methods or trading strategies. There is an infinite numbers of trading strategies for selective hedging. The growth of personal computers during 80s and 90s has increased the use of selective hedging.

38. Some useful thoughts on hedging If you determine a proper hedge will yield a price objective and you are happy with the price, then don�t change your plan when you see that you can get higher price by dropping the plan. The purpose of the plan is to minimize the greed factor of the hedge. Hedging is not something that should be done all the time. Consider each cash position separately and determine the risk of remaining unhedged and the risk of hedging and then make a decision concerning whether or not to hedge.

39. Some useful thoughts on hedging If you are a novice: Hedge on hypothetical account first. Act as if you are actually hedging and learn from the results. After numerous paper trades, then move to limited real hedging, perhaps with mini contracts and gradually develop a personal hedging program suited to your own individual needs.