1. USES OF OPTIONS MARKETS Why are options markets useful? –To obtain information for decision making –For trading Speculation Hedging (“insurance”)

2. USES OF OPTIONS: SPECULATION Options greatly facilitate use of superior market information: –Little capital required –No need to handle commodity (e.g., transportation, storage, etc.) –As easy to speculate DOWN as UP

3. USES OF OPTIONS: SPECULATION (cont.) –Option holders (i.e., buyers) No margins “Unlimited” profit potential Known cost (“premium”)

6. USES OF OPTIONS: SPECULATION Option writers (i.e., sellers) –Margins –“Limited” profit potential (maximum profit = “premium”) –“Unlimited” loss potential

9. OPTIONS ON FUTURES: ACCOUNTING Brokerage fee Margin (“performance bond”): Required for “writers” but not for “holders” –Initial margin –Maintenance margin –Margin call –Settlement price

10. USES OF OPTIONS: SPECULATION Advantages of speculating with options: –Holder’s maximum potential loss limited to premium paid to purchase option

11. Exercise AUG06 LIVE CATTLE OPTIONS Futures at $80.22 StrikeCallPut 74-----0.97 76-----1.55 78-----2.33 802.683.55 821.804.90 841.156.55 860.708.33

12. USES OF OPTIONS: SPECULATION Advantages of speculating with options: –Holder’s maximum potential loss limited to premium paid to purchase option –Options provide menu of alternatives

13. BULLISH SPECULATOR Current Futures

14. BEARISH SPECULATOR Current Futures

15. USES OF OPTIONS: SPECULATION Advantages of speculating with options: –Holder’s maximum potential loss limited to premium paid to purchase option –Options provide menu of alternatives –Options allow for better fit of expectations

16. BULLISH SPECULATOR WITH “TIGHT” EXPECTATIONS Futures at Maturity Current Futures 3 Speculator’s subjective expectations about futures at maturity

18. BULLISH SPECULATOR WITH “TIGHT” EXPECTATIONS Current Futures

19. BEARISH SPECULATOR WITH “TIGHT” EXPECTATIONS Futures at Maturity Current Futures 3 Speculator’s subjective expectations about futures at maturity

21. BEARISH SPECULATOR WITH “TIGHT” EXPECTATIONS Current Futures

22. USES OF OPTIONS: SPECULATION Advantages of speculating with options: –Holder’s maximum potential loss limited to premium paid to purchase option –Options provide menu of alternatives –Options allow for better fit of expectations –Options allow us to exploit superior information about VOLATILITY

23. SPECULATOR WITH HIGH VOLATILITY EXPECTATIONS Current Futures

24. SPECULATOR WITH HIGH VOLATILITY EXPECTATIONS Current Futures

25. SPECULATOR WITH LOW VOLATILITY EXPECTATIONS Current Futures

27. SPECULATOR WITH LOW VOLATILITY EXPECTATIONS Current Futures

28. USES OF OPTIONS: SPECULATION Warning: –It is very difficult to consistently speculate profitably Premiums already reflect expectations of market participants