Agricultural Marketing ECON 337: Agricultural Marketing Lee Schulz Assistant Professor lschulz@iastate.edu 515-294-3356 1

Option Premiums Can be divided into two sections: Intrinsic value What is the option worth today? Time value How much time is left on the option? Intrinsic value depends on the futures price and the strike price of the option. Time value depends on the length of time in the option and the price volatility in the market.

Option Premiums Intrinsic value will not be less than zero. Remember, you have the right to exercise an option, not the obligation. So if the option is losing money, you can just let it expire. Time value will gradually approach zero as the expiration date approaches. Option premium = Intrinsic value + Time value Call intrinsic value = Underlying price - Strike price Put intrinsic value = Strike price - Underlying price

Example Start with an December 2018 corn put option @ $3.90 per bushel Day Futures Price Option Premium Intrinsic Value Time Value 1 $3.8550 $0.32375 $0.0450 $0.27875 2 $3.8725 $0.31125 $0.0275 $0.28375 3 $3.9625 $0.27375 $0.0000 4 $3.9450 5 $3.9325 $0.29125

Combination Strategies Option fence Buy put and sell call Put spread Buy In-the-money or At-the-money put and sell Out-of-the-money put

Option Returns in a Fence Buy Put Option Dec. 2018 Corn @ $3.50 Premium = $0.05375 Sell Call Option Dec. 2018 Corn @ $4.50 Premium = $0.0975

Fence for Speculator Buy Put Option Dec. 2018 Corn @ $3.50 Premium = $0.05375 Sell Call Option Dec. 2018 Corn @ $4.50 Premium = $0.0975

Fence for Hedger Buy Put Option Dec. 2018 Corn @ $3.50 Premium = $0.05375 Sell Call Option Dec. 2018 Corn @ $4.50 Premium = $0.0975

Option Returns in Spread Buy Put Option Dec. 2018 Corn @ $4.50 Premium = $0.7025 Sell Put Option Dec. 2018 Corn @ $3.50 Premium = $0.05375

Spread for Speculator Sell Put Option Dec. 2018 Corn @ $3.50 Premium = $0.05375 Buy Put Option Dec. 2018 Corn @ $4.50 Premium = $0.7025

Spread for Hedger Sell Put Option Dec. 2018 Corn @ $3.50 Premium = $0.05375 Buy Put Option Dec. 2018 Corn @ $4.50 Premium = $0.7025

Combination Strategies Butterfly Straddle Condor Strangle These positions can be flipped

Condor Sell Put @ $3.00 Premium = $0.0050 Sell Call @ $6.00 Buy Put @ $4.00 Premium = $0.3075 Buy Call @ $5.00 Premium = $0.04875

Condor for Hedger

The 4 Basic Graphs for Options Buy a put Sell a put Buy a call Sell a call

Class web site: Have a great weekend! http://www2.econ.iastate.edu/faculty/hart/Classes/econ337/Spring2018/index.htm Have a great weekend!