What is a Futures Option?
• Gives the buyer, the right, but not the obligation to take on a
futures market position.
• Pay a price for this right, but once paid there is no other cost
unless you choose to exercise the option.
• Two types of options:
A call option gives its owner the right to buy something.
A put option gives its owner the right to sell something.
Every option contract has both a buyer and a seller Puts and
Calls are separate option contracts; they are not the opposite
side of the same transaction.
• Options Analogy
• Options can be written for almost anything of value
• They can be a written agreement.
• Example Buying a house or any valuable asset
or
• Exchange traded options
• Grains
• Metals
• Livestock
• Stocks
• Bonds
• ETF’s
Underlying Asset
• Options are available on a wide variety of
investments including stocks, bonds, currencies and
commodities.
• For the purpose of this lesson we will use “Grain
Futures” options traded on the CBOE (Chicago
Board Options Exchange)
Types of Options
• A call option gives its buyer the option to purchase
an agreed quantity of a commodity or financial
instrument (asset), from the seller of the option by a
certain date, for a certain price
• A put option gives its buyer the right to sell the
underlying asset at an agreed-upon price before the
expiry date.
Buyers and Sellers
• Every Option requires that there be a buyer and a
seller
• All options are traded through a clearing house
• Buyers and sellers are anonymous
• Exchange traders will take the opposite side of a
trade where there is no bid or ask.
• Key point …..
oFor every buyer there is a seller
oFor every seller there is a buyer
CALL Option (Buyer)
• Long the call (bullish)
• Also called the holder
• Acquires the right to buy
• Pays premium
• Specific price & time
• Has right to exercise
• No obligation
• Limited loss position
• Unlimited gain position
PUT Option (Buyer)
• Owns (long) the put
• Also called the put holder
• Acquires the right to sell
• Pays premium
• Specific price & time
• Has right to exercise
• No obligation
• Limited loss position
• *Unlimited gain position
Questions
Call Options give their holder
A The obligation to Buy the underlying futures contract at a
fixed price?
B The right to Sell the underlying futures contract at a fixed
price?
C The right but not the obligation to Buy the underlying
futures contract at a fixed price?
D The right but not the obligation to Sell the underlying
futures contract at a fixed price?
Questions
Put Options give their holders the right to:
A. Sell the underlying derivative
B. Sell a call
C. Buy the underlying derivative
D. Buy a call
The process by which a futures contract is terminated
by a transaction that is equal and opposite from the
one that initiated the position is called?
A. Open Interest
B. Offset
C. Delivery
Questions
Options Characteristics
• Have an expiration date
• Can be used as a hedging instrument
• Can be used to amplify profits
• Cost a fraction of the underlying product
• Strike Price/ Exercise Price Intervals
• Part of the premium is time value
• The more time left, the more expensive the option
• Options lose value with time
• Holders and Writers
Strike Price (Exercise Price)
• The price at which the buyer or holder of a “Call”
has the right to purchase a futures contract
or
• The price at which the buyer of a “Put” has the right
to sell a futures contract when the option is
exercised.
Strike price = Exercise price
Strike Price
• The closer to the Strike price the more costly the
option
• The more time value in the option the more costly
the option
• Many levels are assigned
• Many months are assigned
• Near the money are high volume
Premium
• The “Cost” component paid or received for the
option.
• Represents the maximum the option buyer can lose.
• Premium can include both “Time” and “Intrinsic”
value.
• The premium is the only term of the option that is
negotiated.
Corn Option Math
• Corn Contract = 5,000 bushels
• Options are priced in cents per bushel
• 1 cent move in price = 1¢ x 5,000 bu or $50.00
• Minimum move is 1/8 of a cent or $50 / 8 = $6.25
• Therefore an option priced at 5’1 = 5 1/8 cents or $256.25
• An option priced at 5’ 7 = 5 7/8 or $293.75
• In the Money Option
• A Call option is in-the-money when the futures price exceeds the
strike price.
• A Put option is in-the-money when the futures price is below the strike
price.
• At the Money Option
• The option strike price and the underlying futures price are roughly
the same.
• Out of the Money Option
Call option: The underlying futures price is below the option
strike price.
Put option: The underlying futures price is above the option
strike price.
• At expiration, the option will have no value, and the holder will
allow it to expire worthless.
Exercise
• The action taken by the buyer of an option to
acquire or sell the underlying futures position
Expiration Date
• The last date upon which an option can be
exercised.
• If it is not exercised or sold before close of business
it becomes worthless.
• Options that are “in the money” or have intrinsic
value will need to be offset or they will be
automatically exercised.
• It is important to understand the clearing rules
regarding the options you are trading.
How Premium is Derived
Intrinsic Value (Net Worth)
+
Extrinsic Value (Time Value + Volatility)
=
Premium of Option
Intrinsic Value
March Corn $3.50 per bushel
• March $3.40 Call 22 cents or $1,100
• Intrinsic Value 10 cents or $ 500
• March $3.50 Call 16 cents or $800.
• Intrinsic Value 0 cents or $000.
Extrinsic Value
March Corn $3.50 per bushel
• March $3.40 Call 22 cents or $1,100
• Intrinsic Value 10 cents or $ 500
• Extrinsic/Time Value 12 cents or $ 600.
• March $3.50 Call 16 cents or $800.
• Intrinsic Value 0 cents or $000.
• Extrinsic/Time Value 16 cents or $800.
Which of the following options will yield a profit to the
purchaser?
A. An expired option that is "at the money."
B. A call option when the price of the underlying commodity
increases above the option's strike price by an amount
greater than the premium paid for the option.
C. A put option when the price of the underlying increases
above the option's strike price by an amount greater than the
premium paid for the option.
Question 1
Question 2
November Soybean contract is $8.50 per bushel
Strike price for a CALL option on a Nov. Soybean is
$8.80 per bushel
Is the option in-the-money, at-the-money, or out-of
the-money?
Question 3
March Soybean contract is $8.50 per bushel
The strike price for a PUT option on a March futures
contract is $8.80 per bushel
Is the option in-the-money, at-the-money, or out-
of-the-money?
Option Holder (buyer)
• Holder (long)
• Pays option premium
• Maximum loss is premium
• Maximum profit is unlimited to zero
• Owns option and all of the rights till expiry
• Your decision whether or not to exercise
• Limited exposure
OPTION PRICING
MARCH WHEAT 410.
CALLS PUTS
Time Intrinsic Change LastStrike
PriceLast Change Time Intrinsic
1 40 6 41.0 370.00 3.1 1.2 3.1 0
4.5 30 4.5 34.5 380.00 4 2.2 4 0
7 20 3.6 27 390.00 7 3 7 0
12 10 3.5 22 400.00 11.1 3.5 11.1 00
17 0 3.1 17 410.00 16.5 4.1 16.5 00
13 0 2.6 13 420.00 22 4.5 12 10
10.4 0 2.2 10.4 430.00 29 5.2 9 20
7.4 0 1.2 7.4 440.00 35 6.1 5 30
5.4 0 1.1 5.4 450.00 43 6.4 3 40
4.1 0 1 4.1 460.00 51.3 6.6 2.3 50
3.1 0 0.6 3.1 470.00 61.5 7.2 1.5 60
2. The buyer (holder) of an option can:
a) Exercise the option
b) Sell the option
c) Allow the option to expire
d) Do any of the above
Questions
Basic Option Strategies
• Buying Puts The right to sell a futures contract at a
given price
• Buying Calls The right to buy a futures contract at a
given price
• Covered Call
• Bull Spreads
Why Buy Puts
• To protect or hedge producer from falling prices
• To speculate on prices going lower
Why Buy Calls
Farmer:
• To maintain a position in the market after you have contracted
your grain.
Speculator:
• To profit from an anticipated rise in the price of grains
Strategy 1
Farmer feels Corn prices are adequate for profit
• His choices include
• Sell his corn on forward contract
Pros
• Profit locked in
Cons
• farmer cannot share in gains if the market moves higher
Strategy 2
Farmer buys a Put option for price protection
Pros
• Farmer is protected from the strike price down on a price
deterioration
• If prices continue to rise, farmer still own his crop and the
maximum loss is the premium paid for the option
Cons
• Farmer pays premium for the option
• Basis is not protected unless he hedges CAD $
Brokerage Account
Canadian firms CIPF protection
Type of Account Spec or hedge
Hedge account Preferred commissions
Proper paperwork for taxes
Services
• Online discount Experienced traders. Less expensive
• Broker assisted Answer basic questions
• Full Service Most expensive, trading advice
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