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44 Terms

1

options

method to hedge commodity price risk

-right to buy or sell a futures contract at a certain price by expiry date

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2

predetermined options elements

-underlying asset

-strike price

-expiry date

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3

options expire..

prior to corresponding futures month it corresponds with

i.e august expiry for September futures position

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4

premium

only options variable, determined by bids and offers, paid by buyer and received by seller

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5

options participants

  • call buyer (long) call seller (short)

  • put buyer (long) put seller (short)

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6

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

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7

sellers of options

-writers/grantors

-receive premiums> assume futures price change risk

-has obligation until expiry date or when contract is offset

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8

put

right to sell at strike price until expiry date

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9

call

right to buy at strike price until expiry date

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10

strike price

price at which a call or put can be exercised

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11

intrinsic value

value of option if exercised

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12

option value

total of intrinsic and time value

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13

put option profitable when..

strike price>futures price

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14

call option profitable when..

strike price<current futures price

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15

time value

remainder value of option premium once intrinsic value has been taken taken out

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16

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

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17

intrinsic call value

futures price-call options strike price

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18

intrinsic put value

put option strike price-futures price

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19

time value

premium-intrinsic value

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20

in the money

-has intrinsic value, option is profitable

put strike price>futures

calls strike price<futures

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21

out of the money

\-option is not profitable and does not have intrinsic value

put strike price<futures

call strike price>futures
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22

at the money

puts and calls strike price=futures prices

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23

option choices

-exercise

-let expire

-offset prior to expiry

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24

under-filling

don’t forward contract 100% of expected product

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25

quality

discounts for lesser grades

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26

forward contract components

-pricing

-title transfer

-delivery

-settlement

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27

forward contract advantages

-can establish favorable price for future delivery

-protect against unfavorable basis movement

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28

forward contract disadvantages

-border closes

-forego upward market shifts

-magnified production risks

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29

basis contract

basis is fixed is contract, along with date, quality, time, quantity

-price locked in on a later date

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30

basis contract advantage

-protects against increased transport costs

-accounts for local supply and demand

-storage costs- bank rates

-handling fees-elevator fees

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31

forward priced contract

-establishes price and basis

-exchange rate can be source of issues

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32

forward basis contract

-basis set, price tbd

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33

methods of price fall protection

-short hedge

-buy put option

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34

short hedge price fall protection

-Sell=short

-benefits from strengthening basis

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35

put option price fall protection

-exercise put option if prices fall>gives you short futures position

-offset position> short cash and long futures position

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36

option combinations price fall protection

basis contract+put

forward contract+call

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37

basis contract+put

-price fall protection

-set basis with contract

-set strike price with put

-prices fall, use

-prices rise, allow to expire

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38

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

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39

higher input cost production methods

-long futures

-Call option

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40

long futures input cost protection

-buy=long

-profit/loss from hedge offsets csh mkt losses

-benefits from weakening basis

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41

call option input cost protection

-buy call option

-prices rise>exercise call for long futures

-offset futures

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42

options combinations for input cost protection

-basis contract+call

-forward contract+put

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43

basis contract+call

-input price rise protection

-sets basis and then buys call

-prices rise>exercise contract

-prices fall>allow expiry

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44

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

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