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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
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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 Sell (Writer) Buy Exercise Long Short Call Sell (Writer) Buy Exercise Short Long
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 4.93 25.00 3.97 30.00 .35 35.00 .05 40.00 . 01 24.00 0.02 25.00 0.06 30.00 1.43 35.00 6.12 40.00 11.09
Premiums: Puts and Calls 10/31/01 Cotton: Z01 Futures at 29.90 Cents Per Pound Calls Puts 24.00 5.91 25.00 4.93 30.00 .68 35.00 .05 40.00 . 01 24.00 0.02 25.00 0.04 30.00 .78 35.00 5.14 40.00 10.11
Change in Intrinsic and Time Value: Question Cotton: Z01 Futures at 28.92 Cents Per Pound on 10/30 And 29.90 Cents Per Pound on 10/31 Calls Premium Intrinsic Time Puts Premium Intrinsic Time 24.00 4.93 4.92 .01 25.00 3.97 3.92 .05 30.00 .35 .00 .35 35.00 .05 .00 .05 40.00 . 01 .00 .01 10/31 24.00 5.91 5.90 .01 25.00 4.93 4.90 .03 30.00 .68 .00 .68 35.00 .05 .00 .05 40.00 .01 .00 .01 24.00 .02 25.00 .06 30.00 1.43 35.00 6.12 40.00 11.09 10/31 24.00 .02 25.00 .04 30.00 .78 35.00 5.14 40.00 10.11
Change in Intrinsic and Time Value: Answer Cotton: Z01 Futures at 28.92 Cents Per Pound on 10/30 And 29.90 Cents Per Pound on 10/31 Calls Premium Intrinsic Time Puts Premium Intrinsic Time 24.00 .02 .00 .02 25.00 .06 .00 .06 30.00 1.43 1.08 .35 35.00 6.12 6.08 .06 40.00 11.09 11.08 .01 10/31 24.00 .02 .00 .02 25.00 .04 .00 .04 30.00 .78 .10 .68 35.00 5.14 5.10 .04 40.00 10.11 10.10 .09 24.00 4.93 4.92 .01 25.00 3.97 3.92 .05 30.00 .35 .00 .35 35.00 .05 .00 .05 40.00 . 01 .00 .01 10/31 24.00 5.91 5.90 .01 25.00 4.93 4.90 .03 30.00 .68 .00 .68 35.00 .05 .00 .05 40.00 .01 .00 .01
Intrinsic and Time Value:Call Underlying Futures at $2.80
Intrinsic and Time Value: Put Underlying Futures at $2.80
Futures and Options: Hedging Differences Futures- Sell Short Options - Buy Put Price falls - Gain from futures, no premium Price rises – Gain from cash Price Locked Price falls- Premium deducted from N.S.P. Price rises – Let put expire, collect price differential over premium cost Price not locked on upside
Price Falls: Zero Basis Futures Sell $7.00 Futures and Price Falls to $6.50 Gain of $.50 in Futures Loss $.50 in Cash Net selling price $7.00 Put 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
Price Rise: Zero Basis Futures 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 Put Buy $7.00 put for $.15 premium and price rises to $7.50. Let put expire Gain of $.50 in cash market Less $.15 premium Net selling price $7.35
Short Hedging: Futures vs. Options Price Rise Greater Than Premium
