OPTIONS

1
COMMODITY MARKETING

• OPTIONS

FUTURES
CASH
2
Commodity Marketing Concepts

• Wk 1 Market Plan Stasko Ch 2
• Wk 2 Cash Marketing Stasko Ch 8
• Wk 3 Futures Stasko Ch 3
• Wk 4 Basis Stasko Ch 4
• Wk 5 Midterm
• Wk 6 Hedging Stasko Ch 4
• WK 7 OPTIONS
• Wk 8 Market Strategy
• Wk 9 Technical Analysis
• Wk 10 No Class Thanksgiving
• Wk 11 Team Presentations

3
Learning Objectives
Options

• After The Lesson, The Student Should Be Able
  To1. Define Option Terminology2. Distinguish
  Between Puts Calls3. Determine The Intrinsic
  Value Of A Put Or Call4. Discuss The Cost Of
  Using Options And Influencing Factors5.
  Calculate Intrinsic Value, Profit Using Puts
  Calls.

4
I. CASH AND FUTURES REVIEW
Learning Objective
1
Define option terminology

• A. Three types of markets for this class
• Cash
• Futures
• Futures Options
• B. Basis is more predictable than cash
• C. Cash futures tend to move together
• D. Hedging with futures prevents lost or gain
  from price changes.

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II. Option Illustration
Learning Objective
1
Define Option Terminology

• A. You Want To Buy 80 Ac Of Land At 2500/Ac.
• B. Buy An Option To Purchase The Land At A Cost
  Of 10/Ac. (Total Of 800) Paid To The Owner So
  He Wont Sell To Anyone Else For 6 Months

C. You Have The Right, But Not The Obligation To
Purchase The Land At 2500/Ac. Anytime In The
Next 6 Months
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Learning Objective
1
Define Option Terminology
D. If Land Price Goes Up, You Still Have The
Right To Purchase At 2500/Ac.

• E. If The Land Price Goes Down, You Let The
  Option Expire And Buy At The Going Price At The
  End Of 6 Months
• F. In Either Case, The Land Owner Keeps The 800
  Option Money
• You Paid The 800 Up Front And Will Not Get It
  Back

7
III. Commodity Option Concepts
Learning Objective
1
Define Option Terminology

• A. An Option Gives The Buyer The Right, But Not
  The Obligation To Buy/Sell A Futures Contract At
  A Certain Price For A Given Period Of Time.
• B. It Is A Form Of Price Risk Mgtment
• C. It Is Price Insurance Against Price Decreases,
  But Keeps The Gains From Price Increases
• D. Cost For The Right Premium

8
Learning Objective
1
Define Option Terminology
E. Futures Options Allow You To
1. Set A Floor Price For Products
2. Set A Ceiling Price For Inputs
3. Profit From Favorable Changes In The Cash
Market
F. Substitution

• Of A Small But Certain Loss (Insurance Premium)
• 1. FOR THE POSSIBILITY OF A LARGE UNCERTAIN GAIN
  (By Producers Of Products )
• 2. . Or The Possibililty Of A Large Uncertain
  Loss (By Users Of Inputs )

9
Iv. Types Of Options
Learning Objective
1
Define Option Terminology

• A. Call Option A Contract That Gives The Right
  (Not The Obligation) To Buy A Futures Contract At
  A Specified Strike Price During A Specified
  Period

1. Calls Are For People Who "Call Commodities
Off The Market
2. Call Option Contracts Protect Buyers From
Higher Prices
10
Iv. Types Of Options
Learning Objective
1
Define Option Terminology
B. Put Option A Contract That Gives The Right
(Not The Obligation) To Sell A Futures Contract
At A Specified Strike Price During A Specified
Period
1. Puts Are For People Who "PUT Commodities On
The Market

• 2. Put Option Contracts Protect Producers
  Against Price Declines

C. It Is Important To Remember That Puts Calls
Are Separate Distinct Contracts, Not Opposite
Sides Of The Same Transactions
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V. Options Terminology
Learning Objective
1
Define Option Terminology

• A. The Underlying Market Is The Futures Market ,
  Not The Cash Market

B. Option Buyer Is A Person Who Obtains The
Rights Conveyed By The Option
1. Call Buyer Can Accept A Buy Position At
Strike Price.
2. Put Buyer Can Accept A Sell Position At
Strike Price.
3. Can Lose Only The Option Premium
C. Option Seller Is The Person Who Grants The
Rights Contained In The Option
D. There Are Put Buyers, Putt Sellers, Call
Buyers, And Call Sellers
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Learning Objective
1
Define Option Terminology
E. Exercise Or Strike Price

• Is The Specified Price At Which The Option
  Purchaser May Buy Or Sell The Commodity Futures
  Contract
• F. Expiration Date Is The Date Which The Rights
  Of The Option Purchaser Expire
• G. Option Premium Relates To The Market Value Of
  The Option, In Effect, The Cost Of The Insurance

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Factors Affecting Premiums
Learning Objective
1
Define Option Terminology

• 1. Difference Between Option Strike Price And
  The Futures Price Of The Commodity. Larger The
  Difference, Greater The Premium

2. Length Of The Time To Expiration Longer The
Time To Expiration, The Greater The Premium
3. Volatility Of The Commodity Greater The
Volatily, Greater The Premium)
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Learning Objective
1
Define Option Terminology

• H. Intrinsic Value Is The Positive Difference
  Between Strike Price Underlying Commodity
  Futures Price
• 1. For A Put Intrinsic Value Is The Amount That
  Strike Price Exceeds The Futures Price
• If The Strike Price Is lt Futures Zero Intrinsic
• 2. For A Call The Intrinsic Value Is The Amount
  That The Strike Price Is Below The Futures Price
• If The Strike Price gt Futures Zero Intrinsic

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Learning Objective
1
Define Option Terminology
3. An Option That Has

• Intrinsic Value Is In The Money
• 4. An Option That Does Not Have Any Intrinsic
  Value Is Out Of The Money
• 5. If The Strike Price Equals The Futures Price,
  Puts And Calls Are At The Money

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Intrinsic Value
Learning Objective
1
Define Option Terminology
Calls
Puts
In TheMoney
Strikegtfutures
Strikeltfutures
At TheMoney
Strikefutures
Strikefutures
Out Of The Money
Strikegtfutures
Strikeltfutures
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Learning Objective
1
Define Option Terminology
I. Time Value

• Is The Portion Of An Option Premium Resulting
  From The Time To Expiration
• Usually Time Value Decreases With Length Of Time
  Until Expiration
• J. To Offset An Option Is To Sell/Buy An Existing
  Option Contract In Order To Cancel Out An
  Existing Option
• K. To Exercise An Option Is To Convert An Option
  Into A Futures Contract

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Learning Objective
1
Define Option Terminology
L. Buyer

• Holder Of A Put Or Call Option
• M. Seller Seller, Writer, Or Grantor Of A Put Or
  Call Option
• N. Cost Is The Cost Or Premium Related To The
  Option
• O Life Of The Trade Is The Length Of Time To
  Expiration Of The Option
• P. Price Is The Strike Price Of The Option

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Vi. Option Example
Learning Objective
Define Option Terminology
1
A. Puts
1. Want The Right To Sell (Put) Corn Futures For
3.00
2. Purchase Option (Right) By Paying A Premium
3. When We Are Ready To Sell
If Pricelt3.00
If Price gt3.00
Sell At Higher Price
Collect On Policy
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Vi. Option Example
Learning Objective
Define Option Terminology
1
Assume That Dec Futures Are At
1. Want The Right To Sell (Put) Corn Futures For
3.00
2. Purchase Option (Right) By Paying A Premium
3. When We Are Ready To Sell
If Pricelt3.00
If Price gt3.00
Sell At Higher Price
Collect On Policy
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Vii. Using Options To Hedge
Learning Objective

• A. Determine Break Even Price On 40 Bu
• 1. Variable Cost

A. Fert
38
B. Seed
26
C. Chemicals
33
97
2. Fixed Cost
70
A. Rent
41
B. Mach Cost
24
135
C. Labor
232
3. Total Cost
Tot Cst/Bu
4. Break Even
232/40 5.80
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B. Determine Profit Needs
Learning Objective

• 1. 100 Ac Of Soys _at_ 40 Bu/Ac
• 4,000 Bushels
• 2. Need 2,400 To Pay Variable Exp
• 3. Profit Per Bushel
• Needed / Bushels
• 2,400 / 4,000
• .06 Per BushelTarget Brkeven Profit
  5.80 .06 5.86

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C. Grower Pre Harvest Hedge A With Price
Decrease
Date
Local Cash
Futures
Options
Basis
5/ 1
Plants 100 Ac Soys
Nov Bid 6.42
Buy Put 6.75 Strike .20 Premium
6.84
.42
Farmer Sell To Elv 5.95
Exec Opt Buy 6.75 Futures
11/ 15
Sell 6.45 Futures
.50
Options Gain/Loss -Prem .10 .30 -20
Profit/L0ss Cash Sale Options - Be Price
.19 5.95 .10 - 5.86
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D. Grower Pre Harvest Hedge A With Price
Increase
Date
Local Cash
Futures
Options
Basis
5/ 1
Plants 100 Ac Soys
Nov Bid 6.42
Buy Put 6.75 Strike .20 Premium
6.84
.42
Farmer Sell To Elv 7.28
Let Opt Expire
11/ 15
.50
Options Gain/Loss - Premium .-20 .00 - .20
Profit/L0ss Cash Sale Options - Be Price
1.22 7.28 -.20 - 5.86
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Iv. Options Costs
Learning Objective

• A. Premium
• 1. Based On Risk
• 2. More Volatile Higher
• 3. Longer Time Higher
• B. Commission
• C. If Buyer Exercises Option
• 1. Initial Margin
• 2. Maintainance Margin

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FUTURES OPTION PRICES
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