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Options Terms

Options Terms. Commodity Marketing Activity Chapter #5. 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

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Options Terms

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  1. Options Terms Commodity Marketing Activity Chapter #5

  2. 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

  3. What is an Option? • Price is called the strike price. • This doesn’t 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

  4. 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

  5. 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

  6. 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)

  7. 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

  8. 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 Compare Put and Call

  9. 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

  10. 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

  11. 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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