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Options trading strategies india
Introduction There are two basic types of options on futures, put options and call options. An option is a subset of the futures market and each option is specific to a certain commodity and futures month for that commodity. Options are similar to insurance in several ways, including some of the related terminology.
Options bought or sold through a commodity futures broker do not have a physical delivery commitment attached to them. Some grain companies offer contracts that use options, although those handled by a grain company generally contain a physical delivery commitment. The purpose of this article is to provide an introduction to options on futures. There is much more information on options available through books and the internet. The Basics - Puts An option is a choice.
From a hedging point of view, buying a put option locks in a minimum futures price at a cost, the premium. For example, a canola producer could buy a put option to protect against price downside from a certain price level.
So, if the price of canola rose during the time that the put option was owned, the canola producer can still sell canola at the higher price. Meanwhile, as the futures price rose, the value of the right to sell canola futures at the fixed option price level will drop, and the premium paid for that option may be lost.
This optional aspect of an option is an important difference from a sell futures position, which locks in a certain futures price. Another important distinction of buying an option compared to having a futures position is that the option premium paid plus commission is the maximum cost of guaranteeing a minimum price. There are no margin calls when you buy an option.
Here is an example of a put option purchase using numbers from the ICE Canada canola market. It is this right that gives the put option a value. The premium of the option will change as the futures price changes, as time passes, and in response to volatility in the underlying futures contract to which that option relates.
From a hedging point of view, buying a call option locks in a maximum futures price. For example, a canola crusher could buy a call option to protect against price upside above a certain price level. Another use of a call option is for replacement strategy. For example, a farmer delivers and prices some canola. Believing that the futures price will rise, the farmer buys call options on a similar quantity of canola to that sold physically.
By doing so, he can benefit from a potential rise in the futures market, thus adding value to the canola already sold. By using the call option purchase for this strategy, risk is limited to possible loss of the premium paid for that call option. Meanwhile, he has the majority of the proceeds from the canola sale and has reduced risk of spoilage and theft on the quantity of canola sold.
Here is an example of a call option purchase using numbers from the ICE Canada canola market. It is this right that gives the call option its value.
If you buy an option, there are three ways to deal with that option: You can exercise the option, that is, create the specific futures position that buying the option has given you the rights for. When that is complete, you no longer own an option, but now have a new futures position. If you exercise a put option, you will create a sell futures position in your account; if you exercise a call option, you will create a buy futures position in your account.
The specific futures position created will be determined by the characteristics of the option that you owned. You can sell the option as an option for its premium, which might be greater or less than the premium when you purchased that option. This alternative is often the best choice. You can sell an option anytime that futures and options are trading. You may be able to capture some option premium that would be lost when exercising the option or letting the option expire.
Brokerage commissions to sell an option are usually less than when you exercise the option. If you hold the option until the end of its life, it may not have any remaining premium. When the remaining option premium is less than the brokerage cost to sell that option, then you would just let the option expire.
Like insurance, in letting an option expire, you could consider that the option provided specific protection i. Intrinsic value is what the option would be worth as a futures position if the option was exercised. Time value is sometimes referred to as risk premium. Two main factors affect time value, and they are time itself, and volatility of the underlying futures price.
Both of these factors are elements of risk. The longer the option life, the greater the risk to someone selling that option. The more volatile the underlying futures contract, the greater the risk to someone selling that option.
Note that, if an option is exercised, any remaining time value in that option is immediately extinguished. Until expiry of the option, there is usually some time value in an option, so it is better to capture some return of that time premium by selling the option rather than exercising it. The premium value of an option is subject to change by open market trading whenever the futures market is trading.
On days when a particular option strike price does not trade, the commodity exchange uses a computer program to estimate the daily settlement value of that option. Alternatively, if the futures price rises, the value of the put option will tend to fall. But, if the futures price rises, it implies that the value of physical canola is also rising. If the option is kept to expiry, and if then the option has intrinsic value i. That sell futures position would then have to be offset at some time before the March canola futures expires.
Delivery Commitment Flexibility Buying an option through a commodity futures broker leaves the basis portion of price open. That can be a good thing if basis levels for the expected delivery period are considered too weak to lock in, or if one does not want at the time to commit to a physical sale to a certain buyer.
The put option is an attractive alternative to crop producers who are concerned about committing to a delivery with the possibility of a crop shortfall on quantity or quality , to those producers who have already forward contracted with physical buyers to their comfort level or to producers who wish to retain the ability to take advantage of possible higher prices.
Summary A first step in planned marketing is to know your costs of production for a crop, and then use that information as a base for establishing profitable price targets as part of a marketing plan.
As a crop producer, using a put option can provide protection from a price drop while retaining flexibility to take advantage of a higher price and still shop for the best buyer in terms of basis and grade. For more information about the content of this document, contact Neil Blue.
This document is maintained by Erminia Guercio. This information published to the web on November 15,