AGEC 420, Lec 38 1

Agec 420

HW #7: Chart - due todayHW #8: Regression – Fri. May 3HW #9: Options in TradeSim

Monday 29th – David Frey, Kansas Wheat Commission

Exam 3: Friday, May 3 - review session??Options – cont.

Position diagrams

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Markets

• CBOT: http://www.cbot.com/

• CME: http://www.cme.com/

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Options - review

Call option:– right to buy the underlying futures contract – at the specified strike price

Put option:– right to sell the futures at the strike price

ReadingPurcell & Koontz – Ch 7CBOT Publication – on web page

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Options – Notes

• Calls and puts are separate contracts – not opposite sides of the same transaction

• Options usually expire before the futures delivery month begins

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Contract Expiration

• Futures– no trades in the last 7 business days of the

delivery month– 1st delivery day - 1st business day of delivery month

• Options– expire 5 business days before delivery begins

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Hedging with Put Options

• Short Hedger– Wants protection from a price decline

– Take a position in futures/options that will make $ if prices decline

– Buy a put option• If price fall – put becomes more valuable - position makes $

• If prices rise – put expires worthless

• Price is not locked-in (upside potential remains – but at a cost)

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Hedging with Put Options

- like buying insurance– Pay a premium to protect against possible loss– Once premium is paid – no further obligation– If price fall – you’re covered

• (because the put option becomes more valuable)

– If price rises – forget about it!

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Sample Option Prices

• Dec corn – – www.cbot.com

• To illustrate– Put-call parity– Time value

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Position Diagram

– shows how net realized price (profit) changes as the futures price changes

Vertical axis: net realized price (profit)

Horizontal axis: futures price

10 AGEC 420, Lec 38

 

Futures @ ????Strike Put Call

230 76 134240 135 94250 206 65260 286 47270 373 33

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Futures @ 2356 Futures @ 2394 (+36)Strike Put Call Put

230 76 134 62 (-14)240 135 94 114 (-21)250 206 65 183 (-23)260 286 47 260 (-26)270 373 33 342 (-31)

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Futures @ 2356 Futures @ 2394 (+36)Strike Put Call Put Call

230 76 134 62 (-14) 154 (+20)240 135 94 114 (-21) 110 (+16)250 206 65 183 (-23) 77 (+12)260 286 47 260 (-26) 55 (+6)270 373 33 342 (-31) 40 (+6)

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Long Cash

Net Price 2.80

2.50

2.20

2.20 2.50 2.80Futures Price

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Short Futures @ 2.50

Net Profit +30

0

-30

2.20 2.50 2.80

+20

+10

-10

-20

Futures Price

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Long Cash + Short Futures @ 2.50

Net Price

2.502.20 2.50 2.80

CashFutures

Hedge

2.80

2.70

2.60

2.40

2.30

2.20