Chapter 6 Commodity Futures Options and Commodity Futures Spreads Flashcards
Option Premium
The amount the buyer pays the seller of the option for the contract
Option Class
Consists of all options of the same type for the same underlying futures contract. Example: All crude calls are one class and all crude puts are another
Options series
consists of only options of the same class with the same excercsie price and expirations. For example, all Crude June 50 calls would be one series of of options and all Crude June 55 calls would be another series.
Buyer of options characteristics 6
- Known as Owner
- Known as Long the option (put or call)
- Has Rights
- Objective is maximum speculative profit
- Enters the contract with the opening purchase
- Wants the option to exercise
Sellers of options characteristics 6
- Known as Writer
- Known as Short
- Has Olbigations
- Objective Premium Income
- Enters the contract with an opening sale
- Wants the option to expire
What happens when an option is exercised?
the buyer has elected to exercise their rights to buy or sell the futures contract, depending on the type of option involved. Exercising an option obligates the seller to perform under the contract.
Possible outcomes of an option 4
- Exercised
- Sold
- Expire
- Exercise Price
What happens when an option is sold
Most individual investors will elect to sell their rights to another investor rather than exercise their rights. The investor who buys the option from them will acquire all the rights of the original purchaser.
What happens when an option expires
The buyer has elected not to exercise their right and the seller of the option is relieved of their obligation to perform.
Exercise Price
The exercise price is the price at which an option buyer may buy or sell the underlying futures contract, depending on the type of option involved in the transaction.
What is another name for exercise price
Strike price
How can the buyer of an option exit the position? 3
- A closing sale
- Exercising the option
- Allowing the option to expire
How can a seller of an option exit or close out their position
- A closing purchase
- Having the Option exercised or assigned to them
- Allowing the option to expire
Maximum Gain Long Calls
Maximum gain is always unlimited
MaxiMaximum loss long calls
The amount paid for the premium is the maximum loss
Determining the breakeven for long calls
The futures contract must appreciate by enough to cover the cost of the investors option premium in order for them to break even at expiration
Breakeven= Strike price + Premium
Maximum gain short calls
always limited to the amount they received when they sold the calls
Maximum loss short calls
Unlimited since there is no limit to how high a futures contract price may rise.
Breakeven for short calls
Breakeven = Strike Price+ Premium
Maximum Gain Long Puts
Maximum Gain= Strike Price - Premium
Maximum loss Long puts
Unlimited because the futures may go up
Breakeven point for long puts
Breakeven= Strike price- premium
Why would someone sell a put
An investor who sells a put believes that the underlying futures contract price will rise and that they will be able to profit from a rise in the futures contract price by selling puts.
The may want to acquire the underlying contract at a cheaper price
What is the obligation of a seller of a put if the buyer decides to exercise the option?
Purchase the underlying futures contract.