options: basic definitions “put” option gives the buyer the right to a short position in the...
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Options: Basic Definitions
“Put” option gives the buyer the right to a short position in the futures market. Seller or writer of the put is assigned a long position IF the option is exercised
“Call” option give the buyer the right to a long position in the futures market. Seller or writer of the call is assigned a short position IF the option is exercised
Calls and Puts
Put
Call
Sell (Writer) Buy
ShortLong
Sell (Writer) Buy
Short Long
Exercise
Exercise
Definitions
• “Strike Price” Specific price owner has right to buy or sell
• “Premium” Cost of buying an option at a particular strike price
• “In the Money” Put—futures is below strike price
• “In the Money” Call—futures is above strike price
• “Intrinsic Value” Difference between the underlying futures and an in the money put or call
• “Time Value” Difference between options premium and intrinsic value
Premiums: Puts and Calls 10/30/01
Cotton: Z01 Futures at 28.92 Cents Per Pound
Calls Puts
24.00 4.9325.00 3.9730.00 .3535.00 .0540.00 . 01
24.00 0.0225.00 0.0630.00 1.4335.00 6.1240.00 11.09
Premiums: Puts and Calls 10/31/01
Cotton: Z01 Futures at 29.90 Cents Per Pound
Calls Puts
24.00 5.9125.00 4.9330.00 .6835.00 .0540.00 . 01
24.00 0.0225.00 0.0430.00 .7835.00 5.1440.00 10.11
Change in Intrinsic and Time Value: Question
Calls Premium Intrinsic Time
24.00 4.93 4.92 .0125.00 3.97 3.92 .0530.00 .35 .00 .3535.00 .05 .00 .0540.00 . 01 .00 .01
10/3124.00 5.91 5.90 .0125.00 4.93 4.90 .0330.00 .68 .00 .6835.00 .05 .00 .0540.00 .01 .00 .01
Cotton: Z01 Futures at 28.92 Cents Per Pound on 10/30And 29.90 Cents Per Pound on 10/31
Puts Premium Intrinsic Time
24.00 .0225.00 .0630.00 1.43 35.00 6.12 40.00 11.09
10/3124.00 .0225.00 .0430.00 .78 35.00 5.14 40.00 10.11
Change in Intrinsic and Time Value: Answer
Calls Premium Intrinsic Time
24.00 4.93 4.92 .0125.00 3.97 3.92 .0530.00 .35 .00 .3535.00 .05 .00 .0540.00 . 01 .00 .01
10/3124.00 5.91 5.90 .0125.00 4.93 4.90 .0330.00 .68 .00 .6835.00 .05 .00 .0540.00 .01 .00 .01
Cotton: Z01 Futures at 28.92 Cents Per Pound on 10/30And 29.90 Cents Per Pound on 10/31
Puts Premium Intrinsic Time24.00 .02 .00 .0225.00 .06 .00 .0630.00 1.43 1.08 .35 35.00 6.12 6.08 .06 40.00 11.09 11.08 .01
10/3124.00 .02 .00 .0225.00 .04 .00 .0430.00 .78 .10 .6835.00 5.14 5.10 .04 40.00 10.11 10.10 .09
Intrinsic and Time Value:Call
Strike Price
(Call)
Premium Intrinsic Value Time Value
2.60 .25 .20 .05
2.70 .16 .10 .06
2.80 .10 0 .10
2.90 .07 0 .07
3.00 .05 0 .05
Underlying Futures at $2.80
Intrinsic and Time Value: Put
Strike Price
(Put)
Premium Intrinsic Value Time Value
2.60 .05 0 .05
2.70 .07 0 .06
2.80 .10 0 .10
2.90 .16 .10 .06
3.00 .25 .20 .05
Underlying Futures at $2.80
Futures and Options: Hedging Differences
Futures- Sell Short Options - Buy Put
Price falls - Gain from futures, no premiumPrice rises – Gain from cashPrice Locked
Price falls- Premium deducted from N.S.P.Price rises – Let put expire, collect price differential over premium costPrice not locked on upside
Price Falls: Zero Basis
Sell $7.00 Futures and Price Falls to $6.50 Gain of $.50 in Futures Loss $.50 in Cash Net selling price $7.00
Buy $7.00 put for $.15 premium and price falls to $6.50. Offset put for $.60 premium Loss of $.50 in cash, gain of $.45 on options Net selling price $6.95
Futures
Put
Price Rise: Zero Basis
Sell $7.00 Futures and Price Rises to $7.50 Gain of $.50 in Cash Loss of $.50 in Futures Net selling price $7.00
Buy $7.00 put for $.15 premium and price rises to $7.50. Let put expireGain of $.50 in cash market Less $.15 premium Net selling price $7.35
Futures
Put
Short Hedging: Futures vs. Options
Comparison of Futures vs. Options: Short Hedging
April 1
Cash Futures Options
Producer has cost of prodn and storage of $2.20 for delivery by 7/1
Sell July corn fut. at $2.25Buy a July $2.25 put for a premiumof .15
Sell July corn at $2.35
July 1
Buy July futures @ $2.35 - $.10
July puts trading for a premiumof $.00. ..Let put expire for a costof .15
Net price: futures hedge = $2.20 + .15 - .10 = $2.25Net price: options hedge = $2.20 +.15 - .15 = $2.20
Price FallsJuly 1
Sell July corn at $2.00 Buys July futures @ $2.00 + $.25
July $2.25 puts trading for$.30..net = $.15 premium diff in offset ($.30 - $.15
Net price: futures hedge = $2.20 - .20 + .25 = $2.25Net price: options hedge = $2.20 - .20 + .15 = $2.15
Price Rises
Short Hedging: Futures vs. Options
Comparison of Futures vs. Options: Short Hedging
April 1
Cash Futures Options
Producer has cost of prodn and storage of $2.20 for delivery by 7/1
Sell July corn fut. at $2.25Buy a July $2.25 put for a premiumof .15
Sell July corn at $2.45
July 1
Buy July futures @ $2.45 - $.10
July puts trading for a premiumof $.00. ..Let put expire for a costof .15
Net price: futures hedge = $2.20 + .25 - .20 = $2.25Net price: options hedge = $2.20 +.25 - .15 = $2.30
Price FallsJuly 1
Sell July corn at $2.00 Buys July futures @ $2.00 + $.25
July $2.25 puts trading for$.30..net = $.15 premium diff in offset ($.30 - $.15
Net price: futures hedge = $2.20 - .20 + .25 = $2.25Net price: options hedge = $2.20 - .20 + .15 = $2.15
Price Rises
Price Rise Greater Than Premium
Long Hedging: Futures vs. Options
Comparison of Futures vs. Options: Long Hedging
April 1
Cash Futures Options
Commercial forward sells corn at $2.30 for delivery by 7/1
Buy July corn fut. at $2.25Buy a July $2.25 call for a premiumof .15
Buy July corn at $2.35
July 1
Sell July futures @ $2.35 + $.10
July calls trading for a premiumof $.23...sell call for $.23net = $.23 -.15 = + $.08
Net price: futures hedge = $2.30 - .05 + .10 = $2.35Net price: options hedge = $2.30 - .05 + .08 = $2.33
Price FallsJuly 1
Buy July corn at $2.00 Sell July futures @ $2.00 - $.25
July $2.25 calls trading for$.00...Let expirenet = -$.15 premium
Net price: futures hedge = $2.30 + .30 - .25 = $2.35Net price: options hedge = $2.30 + .30 -.15 = $2.45
Price Rises
Buyer: Puts
1) Exercise the option2) Let the option expire3) Sell the option (offset or retrade)
Collect premiumOffset or retrade
Options
Let option expireOffset or retrade
Price Increases
Price Decreases
Exercise: Assigned futures shortOffset or retrade
Assigned futures longOffset or retrade
Seller (Writer): Puts
1) Hold option till buyer either exercises or lets expire2) Offset or retrade
Options: Put Buyer-Seller Choices
Options: Call Buyer-Seller Choices
Buyer: Calls
1) Exercise the option2) Let the option expire3) Sell the option (offset or retrade)
Collect premiumOffset or retrade
Options
Let option expireOffset or retrade
Price Increases
Price Decreases
Assigned futures shortOffset or retrade
Exercise: Assigned futures longOffset or retrade
Seller (Writer): Calls
1) Hold option till buyer either exercises or lets expire2) Offset or retrade
Options: Calls- Retrade
Retrading
Individual buys a corn call at $2.10 for $.15 Current price is $2.10
Action
$2.10 call price premium rises to $.25Individual sells the $2.10 strike price for $.25Net is $.25- .15 -.01 brokerage fee - int. 01 = $.08
December corn futures rises to $2.35
Price Increases to $2.35
Price Decrease to $2.00
$2.10 call price premium falls to $.05Individual sells the $2.10 strike price for $.05Net is $.05 - .15 -.01 brokerage fee - int. 01 = -$.12
Futures fall to $2.00
Options: Calls-Exercising Option
Exercising the Option
Individual buys a Dec. corn call at $2.10 for $.15Current price is $2.10
Action
December corn futures rises to $2.35
Price Increases to $2.35
Individual exercises the call option and receives a buyposition for the Dec. futures market at $2.10. Postsmargin of $650. Sells corn futures to offset for $2.35
+ $.25 per bushel on futures- .15 premium- .01 brokerage fee- . 01 intererst cost
____
.08 net
Summary Considerations
Action in Following Examples
1) Exercise the option if price falls2) Let the option expire if price rises3) Sell the option (offset or retrade)
Buyer: Puts Seller (Writer): Puts
1) Hold option till buyer either exercises or lets expire2) Offset or retrade
Buyer: Calls
1) Exercise the option if price rises2) Let the option expire if price falls3) Sell the option (offset or retrade)
Seller (Writer): Calls
1) Hold option till buyer either exercises or lets expire2) Offset or retrade
1) We will use the same premium values for puts and calls for ease of arithmetic calculation only2) We will use the same arithmetic values for price increases and decreases..as well as the same commodity (corn)2) We will ignore the retrading or offsetting option and consider the end result of call or put exercises
Options: Covered Options
Writing Covered Puts w/Price Increase
Covered Option (Sell)
Options writer sells a corn put on Dec. Corn@ $2.10 strike prices for $.15
Sells December Corn futures @ $2.10posts $650 margin
Action
Option buyer lets options expireWriter has premium of $.15
December corn futures rises to $2.35Writer buys corn futures @ $2.35
$.15 premium -.25 loss in futures -.01 futures commission -.01 interest-.12 loss
Price Increases to $2.35
Net to Writer
Writing Covered Puts w/Price Decrease
Options: Choices
Covered Option (Sell)
Options writer sells a corn put on Dec. Corn@ $2.10 strike prices for $.15
Sells December Corn futures @ $2.10posts $650 margin
Action
Buyer exercises receives sellers short positionWriter has gain in value of premium of $.15
Writer transfers futures to buyer, no gainto writer
$.15 premium
Price Decreases to $2.00
Net to Writer (excluding int.
Writing Covered Calls w/ Price Increase
Covered Call Option (Buy)
Options writer sells a call on Dec. Corn@ $2.10 strike prices for $.15
Buys December Corn futures @ $2.10posts $650 margin
Action
Option buyer exercises option, receives sellerslong positionWriter has profit of premium of $.15
December corn futures rises to $2.35Writer has transferred ownership of $2.10 long to buyer, thus no futures gain
$.15 premium
Price Increases to $2.35
Net to Writer (Exc. int.
Writing Covered Calls w/Price Decrease
Covered Call Option (Buy)
Options writer sells a call on Dec. Corn@ $2.10 strike prices for $.15
Buys December Corn futures @ $2.10posts $650 margin
Action
Buyer lets option expireWriter has premium of $.15
December corn futures fall to $2.00Writer offsets futures by selling DecCorn futures at $2.00 or a $.10 loss
$.15 premium .10 loss in futures+.05 profit
Price Decreases to $2.00
Net to Writer (Exc. int. Other
Writing Naked Puts w/ Price Increase
Naked Option (Sell)
Options writer sells a put on Dec. Corn@ $2.10 strike prices for $.15
December Corn futures @ $2.10Writer has no futures position
Action
Buyer lets options expireSeller (writer) has premium of $.15
December corn futures rises to $2.35
$.15 premium
Price Increases to $2.35
Net to Writer (Exc. int., other)
Writing Naked Puts w/Price Decrease
Naked Option (Sell)
Options writer sells a put on Dec. Corn@ $2.10 strike prices for $.15
December Corn futures @ $2.10Writer has no futures position
Action
Buyer exercises option
Clearing corp. puts seller long and buyershort @ $2.10
Writer offsets by selling futures for a loss of$.10
December corn futures falls to $2.00
$.15 premium - $.10 loss on futures = $.05
Price Decreases to $2.00
Net to Writer (Exc. int. other)
Writing Naked Calls w/Price Increase
Naked Option (Call)
Options writer sells a call on Dec. Corn@ $2.10 strike prices for $.15
December corn futures @ $2.10writer has no futures position
Action
Buyer exercises optionClearing corporation puts seller shortand buyer longWriter offsets by selling futures for a lossof $.25
December corn futures rises to $2.35
+ $.15 premium- . 25 futures loss- $.15 Net loss
Price Increases to $2.35
Net to Writer (Exc. int., other)
Writing Naked Calls w/Price Decrease
Naked Option (Call)
Options writer sells a call on Dec. Corn@ $2.10 strike prices for $.15
December corn futures @ $2.10writer has no futures position
Action
Buyer lets options expireSeller (writer) has premium of $.15
December corn futures falls to $2.00
+ $.15 premium
Price Falls to $2.00
Net to Writer (Exc. int., other)
Writing Options: Summary
Covered and Naked Options Writing
Puts Gainspremium
Writer
Calls
If no price change occurs, writer's net is the premiumin all cases
Price Increase
Naked Covered CoveredNaked
Price Decrease
UnlimitedLoss Pot.
UnlimitedLoss Pot.
Gainspremium
UnlimitedLoss Pot.
Gainspremium
Gainspremium
UnlimitedLoss Pot.