Options Strategies

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Options Strategies

• Commodity Marketing Activity
• Chapter 6

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Option Premiums

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

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Option Premiums

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

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Hog Producer Example

• In June, you expect to have 525 hogs ready for
  market in November
• Local buyer offers 44.50/cwt, your target is
  higher
• You want protection if prices fall, but want to
  take advantage if prices rise
• First Step set your target price

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Target Price

• Strike Price 52.00 50.00 46.00
• Prem. Cost 4.50 2.75 .75
• Expect Basis -2.00 -2.00 -2.00
• Target Price 45.50 45.25 43.25
• You want to establish a minimum price of 45/cwt
• You will need 3 options to protect 400 hogs
• You have the 3,300 (2.75 x 400 per option) so
  you buy the 50 Dec. put option

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Prices Fall

• In November, futures fall to 45, local cash
  price is 43 (basis -2)
• Dec 50 hog put option premium 5
• You sell 3 Dec 50 puts and get the 5 (2.25/cwt
  profit)
• You sell hogs locally for 43
• Total income 43 2.25 45.25
• 2,700 gain over cash market alone

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Prices Rise

• Futures rise to 49
• Sell Dec 50 put for premium of 1 (loss of 1.75)
• Cash Price 47
• Total Income 47 - 1.75 45.25

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Prices Rise

• Futures price 52
• Put Option is worthless
• Let Option expire, lose 2.75
• Sell hogs for 50
• Total income 50 - 2.75 47.25

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Storage Stragegy

• November, you have 35,000 bu of corn
• Cash price 2.20
• Cash Forward Contract (July) 2.60
• Storage cost is .28/bu
• Want to lock in min. of 2.60 and benefit of
  price rises
• Expected Basis -10 cents
• Calculate Target Price

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Target Price

• Strike Price 3.00 2.90 2.80
• Prem. Cost .22 .15 .10
• Exp. Basis - .10 - .10 - .10
• Target Price 2.68 2.65 2.60
• Cur. Cash Pr. 2.20 2.20 2.20
• Storage Gain .48 .45 .40

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Action

• You will need 7 option contracts
• Cost of Premiums will be
• .22 x 35,000 7,700 (3 strike) or
• .15 x 35,000 5,250 (2.90 strike)
• Based on cash flow, you choose 2.90 strike price

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Prices Rise

• In July, Futures price 3.10, and Cash Price
  3.00
• July 290 put is worthless, let it expire, lose
  .15/bu
• Sell corn for 3 in cash market
• Total income 3.00 - .15 2.85 vs 2.30 if
  Forward Contract

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Prices Fall

• Futures price 2.35, cash 2.25
• Sell July Corn 290 puts at higher premium (.55)
  for profit of .40/bu
• Total income 2.25 .40 2.65

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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
• In July, you planning to buy 240 feeder cattle in
  December
• Establish Target Price

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Target Price

• Strike Price 64.00 62.00 60.00
• Prem. Cost 2.55 3.90 5.70
• Expect Basis 1.00 1.00 1.00
• Target Price 67.55 66.90 66.70
• Target max. purchase price 67/cwt, rule out 64
  call option
• 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)

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Prices Fall

• Buy 4 January feeder cattle 62 calls at 3.90/cwt
• In December, futures price 58, cash price
  59
• Jan. Calls are worthless, let expire, lose 6,864
• Buy feeder cattle at 59/cwt
• Total cost 59 3.90 62.90

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Prices Rise

• Futures price 70, cash price 71
• Sell option for 8 (4.10 profit)
• Buy cattle for 71
• Total cost 71 - 4.10 66.90

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