exam 3 study

method to hedge commodity price risk

-right to buy or sell a futures contract at a certain price by expiry date

-underlying asset

-strike price

-expiry date

prior to corresponding futures month it corresponds with

i.e august expiry for September futures position

only options variable, determined by bids and offers, paid by buyer and received by seller

• call buyer (long) call seller (short)

• put buyer (long) put seller (short)

-option holders

-risk is premium

-has the right to take a futures position with no required margin

Has right to offset, exercise, or allow to expire

-writers/grantors

-receive premiums> assume futures price change risk

-has obligation until expiry date or when contract is offset

right to sell at strike price until expiry date

right to buy at strike price until expiry date

price at which a call or put can be exercised

value of option if exercised

total of intrinsic and time value

strike price>futures price

strike price<current futures price

remainder value of option premium once intrinsic value has been taken taken out

-decline in time value as fewer days remain until option expires

-premium for an option will drop in time value as expiry gets closer

futures price-call options strike price

put option strike price-futures price

premium-intrinsic value

-has intrinsic value, option is profitable

put strike price>futures

calls strike price<futures

puts and calls strike price=futures prices

-exercise

-let expire

-offset prior to expiry

don’t forward contract 100% of expected product

discounts for lesser grades

-pricing

-title transfer

-delivery

-settlement

-can establish favorable price for future delivery

-protect against unfavorable basis movement

-border closes

-forego upward market shifts

-magnified production risks

basis is fixed is contract, along with date, quality, time, quantity

-price locked in on a later date

-protects against increased transport costs

-accounts for local supply and demand

-storage costs- bank rates

-handling fees-elevator fees

-establishes price and basis

-exchange rate can be source of issues

-basis set, price tbd

-short hedge

-buy put option

-Sell=short

-benefits from strengthening basis

-exercise put option if prices fall>gives you short futures position

-offset position> short cash and long futures position

basis contract+put

forward contract+call

-price fall protection

-set basis with contract

-set strike price with put

-prices fall, use

-prices rise, allow to expire

-price fall protection

-product committed to price

-call opens opportunity

-when product is delivered and cash collected, we can also exercise option

-prices increase> exercise option by buying futures and receiving hedge profit

-prices decrease>protected by contract

-long futures

-Call option

-buy=long

-profit/loss from hedge offsets csh mkt losses

-benefits from weakening basis

-buy call option

-prices rise>exercise call for long futures

-offset futures

-basis contract+call

-forward contract+put

-input price rise protection

-sets basis and then buys call

-prices rise>exercise contract

-prices fall>allow expiry

-input price rise protection

-sets price and basis then buys put

-opens opportunity to profit from lower price

-prices lower>exercise option and sell at lower price and make hedge profit

-prices raise>locked in at original price