Options Strategies Commodity Marketing Activity Chapter 6

Options Strategies Commodity Marketing Activity Chapter #6

Option Premiums EX: corn put option premium = $. 20 l Corn contract = 5, 000 bu l Buyer of a corn put pays $1, 000 ($. 20 x 5, 000) to the seller of the put l If the option is worthless at the time he is ready to sell his corn, let it expire, and lose $1, 000 l If the value is above $0, he can offset it by selling it back and MAY gain a profit l No Margin Deposit is required l

Option Premiums The Seller takes a greater risk l If Seller wants to OFFSET his put, he must buy the same futures contract l – margin deposit required – to guarantee against any loss l Producer must pay a commission to broker to trade options

Hog Producer Example In June, you expect to have 525 hogs ready for market in November l Local buyer offers $44. 50/cwt, your target is higher l You want protection if prices fall, but want to take advantage if prices rise l First Step = set your target price l

Target Price Strike Price $52. 00 $50. 00 $46. 00 Prem. Cost $ 4. 50 $ 2. 75 $. 75 Expect Basis $-2. 00 Target Price $45. 50 $45. 25 $43. 25 l You want to establish a minimum price of $45/cwt l You will need 3 options to protect 400 hogs l You have the $3, 300 ($2. 75 x 400 per option) so you buy the $50 Dec. put option

Prices Fall In November, futures fall to $45, local cash price is $43 (basis = -$2) l Dec 50 hog put option premium = $5 l You sell 3 Dec 50 puts and get the $5 ($2. 25/cwt profit) l You sell hogs locally for $43 l Total income = $43 + $2. 25 = $45. 25 l $2, 700 gain over cash market alone l

Prices Rise Futures rise to $49 l Sell Dec 50 put for premium of $1 (loss of $1. 75) l Cash Price = $47 l Total Income = $47 - $1. 75 = 45. 25 l

Prices Rise Futures price = $52 l Put Option is worthless l Let Option expire, lose $2. 75 l Sell hogs for $50 l Total income = $50 - $2. 75 = $47. 25 l

Storage Stragegy November, you have 35, 000 bu of corn l Cash price = $2. 20 l Cash Forward Contract (July) = $2. 60 l Storage cost is $. 28/bu l Want to lock in min. of $2. 60 and benefit of price rises l Expected Basis = -10 cents l Calculate Target Price l

Target Price Strike Price Prem. Cost Exp. Basis Target Price Cur. Cash Pr. Storage Gain $3. 00 $. 22 $-. 10 $2. 68 $2. 20 $. 48 $2. 90 $. 15 $-. 10 $2. 65 $2. 20 $. 45 $2. 80 $. 10 $-. 10 $2. 60 $2. 20 $. 40

Action You will need 7 option contracts l Cost of Premiums will be: l – $. 22 x 35, 000 = $7, 700 – $. 15 x 35, 000 = $5, 250 l ($3 strike) or ($2. 90 strike) Based on cash flow, you choose $2. 90 strike price

Prices Rise In July, Futures price = $3. 10, and Cash Price = $3. 00 l July 290 put is worthless, let it expire, lose $. 15/bu l Sell corn for $3 in cash market l Total income = $3. 00 - $. 15 = $2. 85 vs $2. 30 if Forward Contract l

Prices Fall Futures price = $2. 35, cash = $2. 25 l Sell July Corn 290 puts at higher premium ($. 55) for profit of $. 40/bu l Total income = $2. 25 + $. 40 = $2. 65 l

Purchasing Strategy As a purchaser of feeder cattle, you buy CALL options to protect yourself against price increases while leaving yourself open to profit from price decreases l In July, you planning to buy 240 feeder cattle in December l Establish Target Price l

Target Price Strike Price $64. 00 $62. 00 $60. 00 Prem. Cost $ 2. 55 $ 3. 90 $ 5. 70 Expect Basis $+1. 00 Target Price $67. 55 $66. 90 $66. 70 l Target max. purchase price = $67/cwt, rule out 64 call option l Total premium for 4 calls: – $3. 90 x 440 cwt x 4 = $6, 864 (62 call) or – $5. 70 x 440 cwt x 4 = $10, 032 (60 call)

Prices Fall Buy 4 January feeder cattle 62 calls at $3. 90/cwt l In December, futures price = $58, cash price = $59 l Jan. Calls are worthless, let expire, lose $6, 864 l Buy feeder cattle at $59/cwt l Total cost = $59 + $3. 90 = $62. 90 l

Prices Rise Futures price = $70, cash price = $71 l Sell option for $8 ($4. 10 profit) l Buy cattle for $71 l Total cost = $71 - $4. 10 = $66. 90 l