Download Chpt 6 - Glen Rose FFA

Options Strategies
Commodity Marketing Activity
Chapter #6
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

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
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

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
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

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

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

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

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
 Cost of Premiums will be:

– $.22 x 35,000 = $7,700
– $.15 x 35,000 = $5,250

($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
 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

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

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

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)
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

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
