Understanding Agricultural

Options
John Hobert
Farm Business Management Program
Riverland Community College
Why are Agricultural Options
Popular?
Options are basically easy to understand
as compared to the Futures Hedge.
An options hedger is protected against
any unfavorable price change.
A hedger does not have to deposit any
margin money or worry about margin
calls.
Why are Agricultural Options
Popular?
Options allow buyers of agricultural
products to set ceiling prices to protect
against price increases.
Options allow the opportunity to gain
from rising markets. (puts)
Options allow the opportunity to gain
from price decreases in the market. (calls)
Why are Agricultural Options
Popular?
Options permit producers to establish
floor prices for protection against
falling markets.
What is an Option?
An Option is simply the right, but
not the obligation, to buy or sell a
futures contract at some
predetermined price at anytime
within a specified time period.
Option terminology:
An option to buy a futures contract is
known as a call option.
An option to sell a futures contract is
known as a put option.
The predetermined futures price at which
the future contract may be bought or sold
is called the strike or exercise price,
strike price being most commonly used.
More Option Terminology:
The premium is the amount paid for
an option.
The individual purchasing an options
contract is referred to as the options
buyer or holder.
An options contract is said to be in the
money when it has intrinsic value.
Intrinsic values in a nut shell:
An option has an intrinsic value if it
would be profitable to exercise the
option.
Call Options have intrinsic value when the
strike price is below the futures price.
Put Options have intrinsic value when the strike
price is above the futures price.
In the Money Examples:
Call Option Example: (Long Position)
Dec corn futures price is $2.50/Bu.
Dec corn call has a strike price of $2.20/Bu.
The contracts intrinsic value is $ .30/Bu.

Put Option Example: (Short Position)

July corn futures price is $2.50/Bu.
July corn put has a strike price of $2.70/Bu.
The contracts intrinsic value is $ .20/Bu.
More Option Terminology:
An options contract is said to be out of
the money when it has no intrinsic value.
An options contract is said to be at the
money when the strike price is equal to
the current market price.
The time value is equal to the premium
less the intrinsic value of the contract.
Out of the Money Examples:
Call Option Example: (Long Position)
Dec corn futures price is $2.20/Bu.
Dec corn call has a strike price of $2.50/Bu.
The contract has no intrinsic value.

Put Option Example: (Short Position)

Jul. corn futures price is $2.70/Bu.
Jul. corn put has a strike price of $2.50/Bu.
The contract has no intrinsic value.
At the Money Examples:
Call Option Example: (Long Position)
Dec corn futures price is $2.50/Bu.
Dec corn call has a strike price of $2.50/Bu.
The contract has no intrinsic value.

Put Option Example: (Short Position)

Jul. corn futures price is $2.70/Bu.
Jul. corn put has a strike price of $2.70/Bu.
The contract has no intrinsic value.
Options Practice Problem:
Assume you pay a premium of $ .30/Bu. for
a call with a strike price of $7.00 and that
the futures price at expiration is $7.50.
What is the intrinsic value?
Is the call in the money, out of the money, or at the
money?
What is the most you can lose on this contract?
What are my margin requirements?
Options Practice Problem 2:
Assume that May November futures for
soybeans are at $8.30/Bu. while the May
November call option strike price is at
$8.50 at a cost of a $ .12 premium.
What is the intrinsic value of the contract?
What is the time value of the contract?
Why does the contract have time value?
What do you hope occurs?
What are my alternatives at the
end an Options contract?
The option buyer obtains the right to
exercise his chosen alternative by
paying the premium to an option
seller.
Exercise his option. (put) or (call)
Sell the option to someone else.
Let the option expire.
Option Basics:
Premiums depend on market conditions such
as volatility, time until an option expires, and
economic variables.
The premium of an option is discovered
through public out-cry in the CBOT pits.
Trading months for options are the same as
those of the underlying futures contracts
discussed in our futures unit of instruction.
More Option Basics:
As futures prices increase or decrease,
additional higher and lower strike prices are
listed.
Option strike prices can be found in daily
newspapers, through on-line quotation
services (DTN), internet, local grain elevators
or brokers.
Commission fees are charged by brokers.
Strike Price Basics:
Strike prices are listed in predetermined
multiples for each commodity:
$ .25 per bushel for soybeans
$ .10 per bushel for corn
$ .10 per bushel for wheat
$ .10 per bushel for oats
$5.00 per ton for SBOM below $200/ton
$10.00 per ton for SBOM above $200/ton
Strike Price Basics Continued:
The listed strike prices will include an at-
or near-the-money option, at least five
strikes below and at least nine strikes
above the at-the-money options.
This applies to both puts and calls.
The five lower strikes would follow
normal commodity intervals.
Strike Price Basics Continued:
The nine higher strikes would include
five at normal intervals above the at-the-
moneys, plus an additional four strikes
listed in even strikes that are double the
normal intervals discussed previously.
Five Strategies for Buying and
Selling Agricultural Options:
Buying put options for protection against
lower prices.
Buying put options for price insurance
when you store your crop.
Writing call options to achieve a higher
effective selling price for a crop you are
storing.
Five Strategies for Buying and
Selling Agricultural Options:
Buying call options at harvest to profit from
a winter/spring price increase.
Buying call options for short-term
protection against rising prices.
Options offer versatility:
They can be used for protection against
declining prices or against rising prices.
They can be used to achieve short-term
objectives or long-term objectives.
They can be used conservatively or
aggressively.
You hold the right to exercise your option
when you feel it is the right time.
Take Home Review Test:
Free Breakfast at the June Meeting for
the individual scoring the highest on the
review test courtesy of JCH.
In case of tie, we will draw for the winner.
This format will be continued in the
future to encourage you to review each
meeting for your benefit.
Next Month:

Strategy Examples for

Buying and Selling
Agricultural Options.