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.
Maximum gain short puts
the premium received when they sold
Maximum loss short puts
Maximum loss= strike price-premium
Breakeven for short puts
strike price- premium
What is the premium?
The Price of the options
Factors that determine the value of an option (premium):5
- The relationship of the underlying futures contract price to the options strike price
- The amount of time to expiration
- The volatility of the underlying futures contract
- Supply and demand
- Interest rates
In the money options
Profitable for buyer
In the money call is greater than strike
In the money put is less than strike
At the money options
Both puts and calls are at the money when the price of the underlying futures contract equals the options exercise price
Out of the money options
A call is out of the money if futures are below strike price
A put is out of the money if futures are above strike price.
What is an options total premium comprised of(2)
Intrinsic value and time value
Intrinsic value of an option
is equal to the amount the option is in the money
Time value of an option
is the amount by which an options premium exceed intrinsic
Time value
is the amount by which an options premium exceeds its intrinsic value. it is the price an investor pays for the opportunity to exercise the option.
Time value formula of a call options
Time value = Premium- (price-strike)
EG 70 Call with a premium of 2 when the futures are trading at 70.5.
Time value= 1.5= 72-70.5
Intrinsic value of an option calculation
Difference of futures trading price and strike price.
eg. Crude June70C with futures trading at 70.5 has an intrinsic value of $0.50
How are treasury bond futures priced
As a percentage of par down to 32nds of 1%.
Calculate the premium of a May Treasury Bond futures 103 Call quoted at 1.32
1.32= 1-32/64%x100,000
= 1.5%*100000=$1,500
How are options for treasury bill futures based
based on $1,000,000 par value of a 13 week treasury bill that has yet to be issued.
Example
A price based treasury bill futures option is quoted at 1$
1%*1,000,000=$10,000
$10,000/4= $2,500
Long straddles
a simultaneous purchase of a call and a put on the same futures contract with the same strike price and expirations month.
When would an investor want to long a straddle
when they expect the futures contract price to be extremely volatile and to make significant move in either direction.
Maximum gain of a long straddle
Because the investor of a long straddle owns the calls, the investors maximum gain is always going to be unlimited
Maximum loss long straddle
limited to the total premium paid
Total premium paid= call premium + put premium
breakeven for long straddle for the call side
Breakeven= Call strike price+ total premium
breakeven for long straddle put side
Breakeven= Put Strike price - total premium
Short straddle definition
simultaneous sell of a call and put on the same futures contract with the same strike price
Why would an investor sell an straddle
they expect the price of a futures contract to trade within a narrow range or to become less volatile and to not make a significant move in either direction.
When might an investor sell a straddle
after a period of extreme volatility if they believe the price movement will diminish.
Maximum gain for short straddle
The amount of the premium received
Maximum loss for a short straddle
unlimited because the investor is short the calls
Breakeven call side for short straddle
Total premium + call strike price
Breakeven put side for short straddle
Total Premium- Put strike price
Straddle SILO Mnemonic SILO
Short inside Long outside
What are the different types of spreads that may be created using either calls or puts? 3
- Price Spread/vertical spread/ money spread
- Calendar Spread/time spread/ Time spread
- Diagonal Spread
Price Spread/ Vertical Spread
Consists of 1 long option and 1 short option of the same class with different strike prices
Calendar Spread/ Time Spread
Contains one long option and one short option of the same class with different expiration months. May also be called a horizontal spread because of how the options are listed in the option chain.
Diagonal Spread
Consists of 1 long option and 1 short option of the same class that have different strike prices and expiration months.
Bull call spreads/ Debit spreads
The investor purchases the call with the lower strike price and simultaneously sells the call with the higher strike price.
Why an investor would purchase a bull call debit spread
believes that the price of the futures contract will rise may purchase a call with a lower strike and a call with a higher strike to offset the risk of losing all of the premium paid for the long call.
Why is a bull call spread called a debit spread
because the right to purchase a futures contract at a lower price for the same amount of time will always be worth more than the right to purchase the same futures contract at a higher price.
Maximum Gain Bull Call Spread
Difference in strike prices- net premium paid
Maximum loss bull call spread
equal to the amount of the net premium paid for the spread
Breakeven point for a bull call spread
Lower strike price+ net premium
Spread Premium Bull Call Spread
The investor will realize a profit on the spread if the difference in the premiums increases or widens.
Bear call spread/ credit call spreads
Sells the call with the lower strike price and siultaneously buys the call with the higher strike price.
When would an investor purchase a bear call spread/ credit call spreads
believes the price of the futures contract will fall may sell the call with the lower strike price and purchase the call with the higher strike price to ensure that their maximum loss is not unlimited.
Bear call spread maximum gain
equal to the net premium or credit received by the investor when they sold the spread
When will an investor receive their maximum gain for a bear call spread/ credit spread
Both options expire
Maximum loss bear call spread
difference in the strike prices- net premium received
Breakeven point for a bear call spread
lower strike+ Net premium
Spread premiums bear call spread
An investor who has established a bear call spread has sold the spread and received a net premium or creti to establish the position. The investor will realize a profit on the spread if the difference in the premiums decreases or narrows.
Bull Call Spread Max gain, Max loss Breakeven, At expiration
Max Gain= Difference in Strike prices- Premium paid
Max loss= net premium paid
Breakeven= lower strike price + premium
At expiration= profitable if spread widens
Bear call spread max gain, max loss, breakeven, at expiration
Max Gain= net premium received
Max loss= difference in strike prices- premium received
Breakeven= lower strike price + premium
At expiration= profitable if spread narrows
When would an investor purchase bear put spread/ debit put spread
decline in the price of a futures contract
Maximum gain Bear Put Spread
difference in the strike prices- net premium paid
Maximum loss bear put spread
equal to the amount of the net premium paid for the spread.
Breakeven point for bear put spread
highest price- net premium paid
Spread premiums bear put spread
investor realizes profit on the spread if the difference in the premiums increases or widens.
bull put spreads/credit put spreads
an investor wishins to profit from a rise in the price of a futures contract may establish a bull put spread, also known as a credit put spread
Bull put spread
will always be a credit put spread because the right to sell a futures contract at a higher price is always going to be worth more than the right to sell the same futures contract at a lower price for the same amount of time.
To establish a bull put spread
sell the put with the higher strike price and purchase the put with the lower strike price.
Maximum gain bull put spread
equal to the credit received by the investor when they sold the spread
Maximum loss bull put spread
difference in the strike prices- net premium received.
Breakeven for a bull put spread
higher strike- net premium received
Spread premiums bear put spread
an investor who has established a bull put spread has sold the spread and received a net premium to establish the position. The investor will realize a profit on the spread if the difference in the premiums decreases or narrows.
Synthetic long futures
Long Call + Short Put
Synthetic Short Futures
Short Call+ Long put
Synthetic long call
Long futures + long put
Synthetic short call
Short futures + short put
Synthetic long put
short futures + long call
Synthetic short put
long future + short call
Long futures short calls/covered calls
and investor who is long futures can receive some partial downside protection and generate some additional income by selling calls against the futures they own. The investor will receive downside protection or will hedge their position by the amount of the premium received from the sale of the calls. While the investor will receive partial downside protection, they will also give up any appreciation potential above the call’s strike price.
Long futures long puts/ married puts
an investor who is long futures and whishes to protect the position from downside risk will receive the most protection by purchaseing a protective put.
Short futures long calls
An investor who has sold futures short would receive the most protection by purchasing a call.
Short futures short puts
Selling puts againts a short futures position will only partially hedge the unlimited upside risk associated with any short sale of futures
Delta
a measure of an options price change in relation so a price change in the underlying contract. All options do not change in price by the same amount when the price of the underlying futures contract changes.
Options that are deep in the money typically have a delta close to?
1 (100%). A change in the price of the underlying futures contract will be reflected 100% in the change in the price of the deep in the money option.
At the money options typically have a delta of what?
50 (50%). 50% of the change in price of the futures contract will be reflected in the price change of the option.
Far out of the money options tend to be
the further the option is out of the money, the lower its delta.
How many options would be needed if protect a futures position using an option delta of 50?
- 50 = 50% so 2 would be needed to protect 100$ of the futures
How do you determine how much an options premium would change given a delta and change in the underlying futures contract?
multiply the price change in the futures contract by the delta.
How do you establish a crack spread
long crude, short fined productios like rbob and heating oil
What is a reverse crack spread
Short 1 crude
Long 1 Rbob
Long 1 Heating oil
Crush Spread
Long june soybeans
Sell July Soybean Meal
Sell June Soybean Oil
What is gross processing margin of a crush spread?
difference between the cost of one bushel of beans and the value of the refined soybean meal and oil produced from the bushel.
When would a reverse crush spread be established?
When speculators who feel that the gross processing margin will decline and may profit from business conditions that hurt the crushers
What is a debit spread
A spread where the more expensive contract is purchased, and the less expensive is sold
What is a credit spread
A spread where the less expensive leg is purchased and more expensive is sold.
What is an intermaturity spread?
involves establishing a position in T-Bill futures while simultaneously establishing an opposite position in T-bond futures.
What is the dollar weighted ratio connected with T-bill-tbond spread
1:10 spread. Tbill contract covers a par value of 1M while T-bond is 100k.
What would an investor do if they felt the interest rates would fall
Buy bonds and sell t-bills. Further out moves more.
Tbill to 3 month treasury bill weighted ratio
4-1
