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Econ 339X, Spring 2011 ECON 339X: Agricultural Marketing Chad Hart Assistant Professor [email protected] u 515-294-9911 John Lawrence Professor [email protected] u 515-294-7801
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Econ 339X, Spring 2011
ECON 339X:Agricultural Marketing
Chad HartAssistant [email protected]
John [email protected]
Econ 339X, Spring 2011
Options What are options?
An option is the right, but not the obligation, to buy or sell an item at a predetermined price within a specific time period.
Options on futures are the right to buy or sell a specific futures contract.
Option buyers pay a price (premium) for the rights contained in the option.
Econ 339X, Spring 2011
Option Types Two types of options: Puts and Calls
A put option contains the right to sell a futures contract.
A call option contains the right to buy a futures contract.
Puts and calls are not opposite positions in the same market. They do not offset each other. They are different markets.
Econ 339X, Spring 2011
Put Option
The Buyer pays the premium and has the right, but not the obligation, to sell a futures contract at the strike price.
The Seller receives the premium and is obligated to buy a futures contract at the strike price if the Buyer uses their right.
Econ 339X, Spring 2011
Call OptionThe Buyer pays a premium and has the
right, but not the obligation, to buy a futures contract at the strike price.
The Seller receives the premium but is obligated to sell a futures contract at the strike price if the Buyer uses their right.
Econ 339X, Spring 2011
Options as Price InsuranceThe person wanting price protection (the
buyer) pays the option premium.
If damage occurs (price moves in the wrong direction), the buyer is reimbursed for damages.
The seller keeps the premium, but must pay for damages.
Econ 339X, Spring 2011
Options as Price InsuranceThe option buyer has unlimited upside
and limited downside risk.If prices moves in their favor, the option
buyer can take full advantage.If prices moves against them, the option
seller compensates them.
The option seller has limited upside and unlimited downside risk.The seller gets the option premium.
Econ 339X, Spring 2011
Option Issues and ChoicesThe option may or may not have value at
the endThe right to buy at $4.00 has no value if the
market is below $4.00.
The buyer can choose to offset, exercise, or let the option expire.
The seller can only offset the option or wait for the buyer to choose.
Econ 339X, Spring 2011
Strike PricesThe predetermined prices for the trade of
the futures in the options
They set the level of price insurance
Range of strike prices determined by the futures exchange
Econ 339X, Spring 2011
Options Premiums Determined by trading in the marketplace Different premiums
For puts and calls For each contract monthFor each strike price
Depends on five variablesStrike pricePrice of underlying futures contractVolatility of underlying futuresTime to maturity Interest rate
Econ 339X, Spring 2011
Option References In-the-money
If the option expired today, it would have valuePut: futures price below strike priceCall: futures price above strike price
At-the-moneyOptions with strike prices nearest the futures price
Out-of-the-money If the option expired today, it would have no valuePut: futures price above strike priceCall: futures price below strike price
Econ 339X, Spring 2011
Options PremiumsDec. 2011Corn Futures$5.76 per bushel
Source: CBOT, 3/20/09
In-the-money
Out-of-the-money
Econ 339X, Spring 2011
Setting a Floor Price Short hedger Buy put option
Floor Price = Strike Price + Basis – Premium –
Commission
At maturity If futures < strike, then Net Price = Floor Price If futures > strike,
then Net Price = Cash – Premium – Commission
Econ 339X, Spring 2011
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Futures Price ($ per bushel)
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Cash Price Futures Return Net
Short Hedge GraphSold Dec. 2011 Corn @ $5.76
Net = Cash Price + Futures Return
Econ 339X, Spring 2011
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Futures Price ($ per bushel)
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Cash Price Put Option Return Net
Put Option GraphPut Option Dec. 2011 Corn @ $5.80Premium = $0.77
Net = Cash Price + Put Option Return
Econ 339X, Spring 2011
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Futures Price ($ per bushel)
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Cash Price Put Option Return Net Hedge
Put Option GraphPut Option Dec. 2011 Corn @ $5.80Premium = $0.77
Econ 339X, Spring 2011
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Futures Price ($ per bushel)
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Cash Price Put Option Return Net
Out-of-the-Money PutPut Option Dec. 2011 Corn @ $4.50Premium = $0.18
Econ 339X, Spring 2011
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Futures Price ($ per bushel)
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Cash Price Put Option Return Net
In-the-Money PutPut Option Dec. 2011 Corn @ $7.00Premium = $1.61
Econ 339X, Spring 2011
Setting a Ceiling Price Long hedger Buy call option
Ceiling Price = Strike Price + Basis + Premium +
Commission
At maturity If futures < strike,
then Net Price = Cash + Premium + Commission If futures > strike, then Net Price = Ceiling Price
Econ 339X, Spring 2011
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Futures Price ($ per bushel)
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pe
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Cash Price Futures Return Net
Long Hedge GraphBought Dec. 2011 Corn @ $5.76
Net = Cash Price – Futures Return
Econ 339X, Spring 2011
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Futures Price ($ per bushel)
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Cash Price Call Option Return Net
Call Option GraphCall Option Dec. 2011 Corn @ $5.80Premium = $0.73
Net = Cash Price – Call Option Return
Econ 339X, Spring 2011
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Futures Price ($ per bushel)
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Cash Price Call Option Return Net Hedge
Call Option GraphCall Option Dec. 2011 Corn @ $5.80Premium = $0.73
Econ 339X, Spring 2011
Combination Strategies Option fence
Buy put and sell callHigher floor, but you now have a ceiling
Put spreadBuy At-the-money put and sell Out-of-the-money putBetter net price at middle and higher prices, but no
floor below Out-of-the-money strike price
Econ 339X, Spring 2011
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Futures Price ($ per bushel)
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Cash Price Net w/ Fence
FenceBuy Put Option Dec. 2011 Corn @ $5.50Premium = $0.59
Sell Call Option Dec. 2011 Corn @ $6.50Premium = $0.50
Econ 339X, Spring 2011
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Futures Price ($ per bushel)
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Cash Price Net w/ Spread
SpreadBuy Put Option Dec. 2011 Corn @ $6.50Premium = $1.23
Sell Put Option Dec. 2011 Corn @ $5.00Premium = $0.35
Econ 339X, Spring 2011
Combination StrategiesButterfly
Condor
Straddle
Strangle
These positions can be flipped
Econ 339X, Spring 2011
Summary on OptionsBuyer
Pays premium, has limited risk and unlimited potential
Seller Receives premium, has limited potential and
unlimited riskBuying puts
Establish minimum pricesBuying calls
Establish maximum prices
Econ 339X, Spring 2011
Class web site:http://www.econ.iastate.edu/~chart/Classes/econ339/Spring2011/
