Options on Futures Separate market Option on the futures contract Can be bought or sold Behave like price insurance – Is different from the new.
Download ReportTranscript Options on Futures Separate market Option on the futures contract Can be bought or sold Behave like price insurance – Is different from the new.
Options on Futures Separate market Option on the futures contract Can be bought or sold Behave like price insurance – Is different from the new insurance products Options on Futures Two types of options Four possible positions – Put » Buyer » Seller – Call » Buyer » Seller 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. Call option The 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. Options as price insurance Person wanting protection pays a premium If damage occurs the buyer is reimbursed for damages Seller keeps the premium but must pay for damages Options May or may not have value at end – The right to sell at $2.20 has no value if the market is above $2.20 Can be offset, exercised, or left to expire Calls and puts are not opposite positions of the same market. They are different markets. Strike price Level of price insurance Set by the exchange (CME, CBOT) A range of strike prices available for each contract Premium Is traded in the option market – Buyers and sellers establish the premium through open out cry in the trading pit. Different premium – For puts and calls – For each contract month – For each strike price In-the-money If expired today it has value Put: futures price below strike price Call: futures price above strike price At-the-money If expired today it would breakeven Strike price nearest the futures price Out-of-the-money If expired today it does not have value Put: futures price above strike price Call: futures price below strike price Option buyer alternatives Let option expire – Typically when it has no value Exercise right – Take position in futures market – Buy or sell at strike price Re-sell option rights to another Buyer decision depends upon Remaining value and costs of alternative Time mis-match – Most options contracts expire 2-3 weeks prior to futures expiration – Cash settlement expire with futures – Improve basis predictability Option seller Obligated to honor option contract Can buy back option to offset position – Now out of market Put option example A farmer has corn to sell after harvest. 1) In May, buy a $2.80 Dec Corn Put Expected basis = -$0.25 Premium = $0.15 Commission = $0.01 Expected minimum price (EMP) = SP + Basis - Prem - Comm = $2.39 Notice that you subtract the premium because it works against you and you are trying to reduce cost. Put option example Lower 2) At harvest futures prices lower. Futures = Cash market = Option value = $2.80-2.50 = Net price = Cash + Return - Cost = $2.25 + 0.30 - 0.15 - 0.01 = $2.50 $2.25 $0.30 $2.39 Put option example Higher 3) At harvest futures prices higher. Futures = Cash market = Option value = Net price = Cash + Return - Cost = $2.90 + 0 - 0.15 - 0.01 = $3.15 $2.90 $0 $2.74 Call option example A feedlot wants to buy corn to feed after harvest. 1) In May, buy a $3.00 Dec Corn Call Expected basis = -$0.25 Premium = $0.20 Commission = $0.01 Expected maximum price (EMP) = SP + Basis + Prem + Comm = $2.96 Notice that you add the premium because it works against you and you are trying to reduce cost. Call option example Lower 2) At harvest futures prices lower. Futures = $2.50 Cash market = $2.25 Option value = $0 Net price = Cash - Return + Cost = $2.25 - 0 + 0.20 + 0.01 = $2.46 Call option example Higher 3) At harvest futures prices higher. Futures = $3.15 Cash market = $2.90 Option value = $3.15-3.00 = $0.15 Net price = Cash - Return + Cost = $2.90 - 0.15 + 0.20 + 0.01 = $2.96 Net Price with Options Buy Put – Minimum price – Cash price - premium - comm Buy Call – Maximum price – Cash price + premium + comm Livestock Risk Protection (LRP) Coverage for hogs, fed cattle and feeder cattle 70% to 95% guarantees available, based on CME futures prices. Coverage is available for up to 26 weeks out for hogs and 52 for cattle. Livestock Risk Protection Guarantees available are posted at: www.rma.usda.gov/tools/ Posted after the CME closes each day until 9:00 am central time the next working day. Assures that guarantees reflect the most recent market movements. Size of Coverage Futures and options have fixed contract sizes – Hogs: 400 cwt. or about 150 head – Fed cattle: 400 cwt. or about 32 head – Feeder cattle: 500 cwt., 60-100 head LRP can be purchased for any number of head or weight Some Risks Remain LRP, LGM do not insure against production risks Futures prices and cash index prices may differ from local cash prices (basis risk) Selling weights and dates may differ from the guarantees Expiration Date of Coverage LRP ending date is fixed. Price may change after date of sale. Hedge or options can be lifted at any time before the contract expires. Who can benefit from LGM/LRP? Producers who depend on the daily cash market or a formula related to it. Producers with low cash reserves. Smaller producers who do not have the volume to use futures contracts or put options. Producers who prefer insurance to the futures market. No margin account. LRP Analyzer Covers swine, fed cattle, feeders Compares net revenue distribution – No risk protection – LRP – Hedge – Put options Case Example Small cow herd producer will have 62 head of 650 pound steer calves to sell in 4 months. What price will LRP lock in? How much will it cost? How does LRP compare to futures? Projected Net Revenue per Head Cash Selling Price, $/cwt. $/head $89.00 $94.00 $99.00 $104.00 $109.00 $114.00 $119.00 $124.00 $250 $200 $150 $100 $50 $0 ($50) LRP highest level PUT Options Hedge No Risk Protection Projected Net Revenue per Head Cash Selling Price, $/cwt. $/head $89.00 $94.00 $99.00 $104.00 $109.00 $114.00 $119.00 $124.00 $250 $200 $150 $100 $50 $0 ($50) LRP highest level PUT Options Hedge No Risk Protection Livestock Gross Margin Cattle – Calves – Yearlings Hogs – Farrow to finish – Finishing feeder pig – Finishing SEW pig Livestock Gross Margin Insures a “margin” between revenue and cost of major inputs Hogs Value of hog – corn and SBM costs Cattle Value of cattle – feeder cattle and corn Protects against decreases in cattle/hog prices increases in input costs LGM Hogs Farrow to Finish option Gross margin per hogt = – 2.5*0.74*LeanHog Pricet – - 13.22 bu. * Corn Pricet-3 – - (188.52 lb./2000 lb.) * SoyMeal Pricet-3 Finish Only option Gross margin per hogt = – 2.5*0.74*Lean Hog Pricet – - 10.19 bu. * Corn Pricet-2 – - (147.31 lb./2000 lb.) * SoyMeal Pricet-2 LGM-Cattle Uses futures markets to lock in the average expected gross margin for fed cattle to be sold in each of the next ten months Protects against decreases in live cattle prices increases in feeder cattle prices and increases in feed costs LGM-Cattle Yearling GM = 12.5 x Basis adjusted LC futures - 7.5 x Basis adjusted FC futures - 57.5 x Basis adjusted Corn futures Calf GM = 11.5 x Basis adjusted LC futures - 5.5 x Basis adjusted FC futures - 55.5 x Basis adjusted Corn futures Learn More About Risk Tools Livestock Revenue Protection Livestock Gross Margin http://www.rma.usda.gov/livestock/ – Factsheets – Premium calculator Livestock Futures and Options Historic basis patterns www.extension.iastate.edu/agdm – Decision file B1-50