Studied by 11 people
options
method to hedge commodity price risk
-right to buy or sell a futures contract at a certain price by expiry date
predetermined options elements
-underlying asset
-strike price
-expiry date
options expire..
prior to corresponding futures month it corresponds with
i.e august expiry for September futures position
premium
only options variable, determined by bids and offers, paid by buyer and received by seller
options participants
call buyer (long) call seller (short)
put buyer (long) put seller (short)
buyers of options
-option holders
-risk is premium
-has the right to take a futures position with no required margin
Has right to offset, exercise, or allow to expire
sellers of options
-writers/grantors
-receive premiums> assume futures price change risk
-has obligation until expiry date or when contract is offset
put
right to sell at strike price until expiry date
call
right to buy at strike price until expiry date
strike price
price at which a call or put can be exercised
intrinsic value
value of option if exercised
option value
total of intrinsic and time value
put option profitable when..
strike price>futures price
call option profitable when..
strike price<current futures price
time value
remainder value of option premium once intrinsic value has been taken taken out
time decay
-decline in time value as fewer days remain until option expires
-premium for an option will drop in time value as expiry gets closer
intrinsic call value
futures price-call options strike price
intrinsic put value
put option strike price-futures price
time value
premium-intrinsic value
in the money
-has intrinsic value, option is profitable
put strike price>futures
calls strike price<futures
out of the money
at the money
puts and calls strike price=futures prices
option choices
-exercise
-let expire
-offset prior to expiry
under-filling
don’t forward contract 100% of expected product
quality
discounts for lesser grades
forward contract components
-pricing
-title transfer
-delivery
-settlement
forward contract advantages
-can establish favorable price for future delivery
-protect against unfavorable basis movement
forward contract disadvantages
-border closes
-forego upward market shifts
-magnified production risks
basis contract
basis is fixed is contract, along with date, quality, time, quantity
-price locked in on a later date
basis contract advantage
-protects against increased transport costs
-accounts for local supply and demand
-storage costs- bank rates
-handling fees-elevator fees
forward priced contract
-establishes price and basis
-exchange rate can be source of issues
forward basis contract
-basis set, price tbd
methods of price fall protection
-short hedge
-buy put option
short hedge price fall protection
-Sell=short
-benefits from strengthening basis
put option price fall protection
-exercise put option if prices fall>gives you short futures position
-offset position> short cash and long futures position
option combinations price fall protection
basis contract+put
forward contract+call
basis contract+put
-price fall protection
-set basis with contract
-set strike price with put
-prices fall, use
-prices rise, allow to expire
forward contract+call
-price fall protection
-product committed to price
-call opens opportunity
-when product is delivered and cash collected, we can also exercise option
-prices increase> exercise option by buying futures and receiving hedge profit
-prices decrease>protected by contract
higher input cost production methods
-long futures
-Call option
long futures input cost protection
-buy=long
-profit/loss from hedge offsets csh mkt losses
-benefits from weakening basis
call option input cost protection
-buy call option
-prices rise>exercise call for long futures
-offset futures
options combinations for input cost protection
-basis contract+call
-forward contract+put
basis contract+call
-input price rise protection
-sets basis and then buys call
-prices rise>exercise contract
-prices fall>allow expiry
forward contract+put
-input price rise protection
-sets price and basis then buys put
-opens opportunity to profit from lower price
-prices lower>exercise option and sell at lower price and make hedge profit
-prices raise>locked in at original price
Note 
Flashcard (53)