Wheat Options Explained

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Wheat Options Explained

Wheat options are option contracts in which the underlying asset is a wheat futures contract.

The holder of a wheat option possesses the right (but not the obligation) to assume a long position (in the case of a call option) or a short position (in the case of a put option) in the underlying wheat futures at the strike price.

This right will cease to exist when the option expire after market close on expiration date.

Wheat Option Exchanges

Wheat option contracts are available for trading at NYSE Euronext (Euronext).

Euronext Milling Wheat option prices are quoted in dollars and cents per bushel and their underlying futures are traded in lots of 50 tonnes of wheat.

Euronext Feeder Wheat options are traded in contract sizes of 100 tonnes and their prices are quoted in pounds and pence per metric ton.

Exchange & Product Name Underlying Contract Size Exercise Style Option Price Quotes
Euronext Milling Wheat Options 50 ton
(Full Contract Specs)
American Calls | Puts
Euronext Feeder Wheat Options 100 ton
(Full Contract Specs)
American Calls | Puts

Call and Put Options

Options are divided into two classes – calls and puts. Wheat call options are purchased by traders who are bullish about wheat prices. Traders who believe that wheat prices will fall can buy wheat put options instead.

Buying calls or puts is not the only way to trade options. Option selling is a popular strategy used by many professional option traders. More complex option trading strategies, also known as spreads, can also be constructed by simultaneously buying and selling options.

Wheat Options vs. Wheat Futures

Additional Leverage

Limit Potential Losses

As wheat options only grant the right but not the obligation to assume the underlying wheat futures position, potential losses are limited to only the premium paid to purchase the option.

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Flexibility

Using options alone, or in combination with futures, a wide range of strategies can be implemented to cater to specific risk profile, investment time horizon, cost consideration and outlook on underlying volatility.

Time Decay

Options have a limited lifespan and are subjected to the effects of time decay. The value of a wheat option, specifically the time value, gets eroded away as time passes. However, since trading is a zero sum game, time decay can be turned into an ally if one choose to be a seller of options instead of buying them.

Learn More About Wheat Futures & Options Trading

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Get to know Agricultural Options on Futures

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Get to Know Agricultural Options on Futures

CME Group provides a wide array of liquid Agricultural options products that offer flexibility for effective risk management, as well as a multitude of trading opportunities. The diverse selection of options on Grains, Oilseeds, Livestock and Dairy products range from outright options and spread options, to cost-effective short-term alternatives.

In this module we will take a look at the various types of Agricultural options available and the features and benefits that make them valuable tools for hedgers and traders.

Standard Options

First of all, there are standard options traded on every Agricultural futures contract, with an option listed that corresponds to each futures delivery month.

For Agricultural futures contracts with physical delivery, standard options expire the month prior to the corresponding futures delivery month.

EXAMPLE

For example, July Wheat options expire in June.

However, for cash-settled Agricultural futures, such as Livestock and Dairy futures, standard options expire the same day as the underlying futures contract.

Other types of Agricultural options may have features that differ from those of standard options, but the main element that distinguishes all of them is the option’s lifespan or the amount of time until an option is scheduled to expire. This is important because the longer amount of time until an option expires, the higher the price or premium of that option.

Serial Options

Like standard options, serial options are listed on every Agricultural futures contract, except for Dairy products. They provide an alternative for those seeking to trade options during a month when a futures contract is not listed. Serial options exercise into the nearby futures contract.

EXAMPLE

Although there is no October futures delivery month listed for Soybeans, you could still trade an October serial option that exercises into the November Soybean futures contract.

Serial options are often used to extend a hedge from one month to the next, and since the time frame is shorter than for a standard option, the option price tends to be lower also.

Short-Dated New Crop options

Short-Dated New Crop options provide a shorter term alternative for trading new crop Corn, Soybeans, Soybean Oil, Soybean Meal and Chicago Soft Red Winter and KC Hard Red Winter wheat. There are also South American Short-Dated New Crop options that are designed to match the new crop Soybean cycle in the southern hemisphere.

Short-Dated New Crop options reference the new crop futures month, the futures month denoting grain in the upcoming harvest, but they expire earlier than the standard options. For example, there is a July Short-Dated New Crop Corn option that expires into the next December Corn futures contract.

Due to this earlier expiration, the amount of time until option expiration is shorter than for a standard December Corn option, so the July Short-Dated option will trade at a lower price than the standard December option. This allows you to manage specific risks during the growing season at a relatively lower cost.

Weekly Options

Like Short-Dated New Crop options, weekly options provide an option alternative with a very short duration—in this case, from 28 days down to just a few days.

There is a weekly option listed that expires every Friday that is not also an expiration for a standard or serial option.

Because of the very short term nature of their exposure, they allow trading based on market moves that occur in specific time frames, as well as targeted risk management strategies around high impact events – such as the release of USDA reports. Weekly options are available on Corn, Soybeans, Soybean Meal, Soybean Oil and Chicago Soft Red Winter and KC Hard Red Winter wheat.

Calendar Spread Options

Calendar Spread Options (CSOs) are based on the price differentials between two delivery months of the same Grain or Oilseed futures contract. They feature smaller strike price intervals than standard options, so they allow more precise hedging of calendar spread risk.

And since CSOs are sensitive only to the value and volatility of the spread itself, rather than the grains or oilseeds market, they offer more efficient protection against adverse movements in calendar spreads, while still providing access to favorable spread changes.

For those interested in trading Agricultural options there are several alternatives available that cater to almost every need.

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Grain Price Options Basics

File A2-66
Updated December, 2009

The basic concepts of grain price options are discussed below. Methods of using grain price options to market grain are presented in:

An option is the right, but not the obligation, to buy or sell a futures contract. The buyer of an option acquires this right. The option seller (writer) must take the opposite side of the option buyer’s futures position. For example, if you buy an option with the right to buy futures, the option seller (writer) must sell futures to you if you exercise the option. Option contracts are traded in a similar manner as their underlying futures contracts. All buying and selling occurs by open outcry of competitive bids and offers in the trading pit.

Types of Options

If you buy an option to buy futures, you own a call option. If you buy an option to sell futures, you own a put option. Call and put options are separate and distinct options. Calls and puts are not opposite sides of the same transaction.

Strike Price

When buying or selling an option, you must choose from a set of predetermined price levels at which you will enter the futures market if the option is exercised. These are called strike prices. For example, if you choose a soybean option with a strike price of $7 per bushel, upon exercising the option you will buy or sell futures for $7. This will occur regardless of the current level of futures price.

Strike prices are listed at predetermined price levels for each commodity: every 25 cents for soybeans, and 10 cents for corn.

When trading is initiated on an option, trading is available at a series of strike prices above and below the current future’s price. For example, if the July corn futures price is $3, there will be corn options introduced with strike prices of $2.80, $2.90, $3.00, $3.10, and $3.20. If futures price increases (decreases), additional strike prices are added.

Delivery Month

When buying an option you must choose which delivery month you want. Options have the same delivery months as the underlying futures contracts. For example, corn options have December, March, May, July, and September delivery months, the same as corn futures. If you exercise a December corn op­tion you will buy or sell December futures.

Closing-out your Option

There are three ways you can close out an option position. The option can be exercised, it can be sold, or the option can be allowed to expire.

Exercise
Exercising an option converts the option into a futures position at the strike price. Only the option buyer can exercise an option. When a call option is exercised, the option buyer buys futures at the strike price. The option writer (seller) takes the opposite side (sell) of the futures position at the strike price. When a put option is exercised, the option buyer sells futures at the strike price. The option writer (seller) takes the opposite side (buy) of the futures position.

Because of the option seller’s obligation to take a fu­tures position if the option is exercised, he/she must post margin money and is faced with the possibility of margin calls.

Offsetting Transaction
If you have already purchased an option, you can offset this position by selling another option with the same strike price and delivery month. You are now out of the options market. The amount of gain or loss from the transaction depends on the premium you paid when you purchased the option and the premi­um you received when you sold the option, less the transaction cost.

However, if the option you sell does not have the same strike price and/or delivery month as the option you originally purchased, you will now have two positions in the market; one as a buyer and another as a seller.

If you have written (sell) an option, you can offset this position by buying an option with the same strike price and delivery month. You are now out of the options market. The amount of gain or loss from the transaction depends on the premium you received when you sold the option and the premium you paid when you repurchased the option, less the transaction cost. However, you run the risk of having the option exercised by the buyer before you offset it.

Expire
An option expires if it is not exercised within the time period allowed. The expiration date is the last day on which the option can be exercised. Options expire in the month prior to contract delivery. For example, a July corn option expires in June.

Call Options

An option to buy a futures contract is a call option. The buyer of a call option purchases the right to buy futures. The seller (writer) of the call option must sell futures (take the opposite side of the futures transaction) if the buyer exercises the option. For the right to exercise the option, the buyer pays the seller a premium.

The buyer of a call option will make money if the futures price rises above the strike price. If the rise is more than the cost of the premium and transaction, the buyer has a net gain.

The seller of a call option loses money if the futures price rises above the strike price. If the rise is more than the income from the premium less the cost of the transaction, the seller has a net loss.

If the futures price drops below the strike price, the option buyer will not exercise the option because exercising will create a loss for the buyer. In this situation the option buyer will let the option expire worthless on the expiration day. The only money transfer will be the premium the option buyer originally paid to the writer.

Put Options

An option to sell a futures contract is a put option. The buyer of a put option purchases the right to sell futures. The writer (seller) of the put option must buy futures (take the opposite side of the futures transaction) if the buyer exercises the option. For the right to exercise the option, the buyer pays the seller a premium.

The buyer of a put option will make money if the futures price falls below the strike price. If the decline is more than the cost of the premium and transaction, the buyer has a net gain.

The seller of a call option loses money if the futures price falls below the strike price. If the decline is more than the income from the premium less the cost of the transaction, the seller has a net loss.

If the futures price rises above the strike price, the option buyer will not exercise the option because exercising will create a loss for the buyer. In this situation, the option buyer will let the option expire worthless on the expiration day. The only money transfer will be the premium the option buyer originally paid to the seller.

Premium

As discussed previously, the amount paid for an option is the premium. The option buyer pays the premium to the option writer (seller) at the time of the option transaction. The premium is the only part of the option contract that is negotiated. All other contract terms are predetermined. The premium is the maximum amount the option buyer can lose and the maximum amount the option seller can make.

An option premium is composed of intrinsic and/or extrinsic value.

Intrinsic Value
The intrinsic value is the amount of gain that can be realized if the option is exercised and the resulting futures position closed out. A call option has in­trinsic (exercise) value if the futures price is above the strike price. A put option has intrinsic (exercise) value if the future price is below the strike price.

Extrinsic Value
Extrinsic (extra) value is the amount by which the option premium exceeds the intrinsic (exercise) value. Extrinsic value is the return that option writers (sellers) demand in return for bearing the risk of loss from an adverse price movement. All option premiums contain extrinsic value except at expi­ration. Because of extrinsic value, an option buyer can sell an option for as much or more than its exercise value.

The amount of extrinsic value is influenced by three factors:

  • Time value – Time value is based on the length of time before the option expires. If the expi­ration date is far-off, time value will be high. As expiration approaches, the time value de­clines. At expiration, no time value remains.
  • Future price vs. strike price – The relationship of the futures price to the strike price affects the extrinsic value. The extrinsic value is highest when the futures price is the same as the strike price. The extrinsic value declines as the fu­tures price moves away (above or below) from the strike price.
  • Market volatility – As the futures market becomes more volatile, the extrinsic value increases.

Other Option Terms

Additional commonly used option terms are discussed below. These option terms pertain to the relationship between the current futures price and the strike price.

In-the-money
An option is in-the-money if it has exercise value. In other words, a call option is in-the-money if the current futures price is above the strike price be­cause it can be exercised at the strike price and sold at the current futures price for a gain. A put option is in-the-money if the current futures price is below the strike price.

Out-of-the-money
An out-of-the-money option has no exercise value. A call option is out-of-the-money if the current futures price is below the strike price. Conversely, a put option is out-of-the-money if the current futures price is above the strike price.

At-the-money
An option is at-the-money if the current futures price is the same as the strike price. A one cent change in the future price will put the option either in-the-money or out-of-the-money.

Below are examples of call and put options that are in-the-money, at-the-money, and out-of-the-money.

Premium Examples

Below are actual examples of soybean option premiums for various strike prices and delivery months. The premium for each strike price and delivery month is listed. In parentheses are the intrinsic (exercise) value and the extrinsic value for each op­tion premium. The current futures prices are at the bottom of the table.

Soybean Call Options – March 1

Soybean call option premiums on March 1 are shown in Table 1. The current futures price for the July and August futures contracts is $6.50. At this price the $6 strike price option is in-the-money by 50 cents. If this option is exercised, the option buyer will own a futures contract purchased at a strike price of $6. The option buyer can then sell the contract at the current $6.50 futures price for a gain of 50 cents ($6.50 – 6.00 = $.50). The $6.00 strike price option has extrinsic value of 8 cents, the difference between the premium and the exercise value.

The $7 strike price July option has a premium of 14 cents. It has no intrinsic value because it is out-of-the-money by 50 cents. Futures price would have to rise by over 50 cents before the option would contain any exercise value. Its extrinsic value is 14 cents.

The $6.50 strike price July option is at-the-money. It has no intrinsic value but has extrinsic value of 29 cents.

The options with strike prices at-the-money and out of-the-money have premiums containing no intrinsic value (exercise value.) Only those options that are in-the-money have premiums with intrinsic value.

Time value
The August options have higher extrinsic values than the July options. For example, the July $6.50 strike price option has extrinsic value of 29 cents while the August $6.50 option’s extrinsic value is 37 cents.

This occurs because the August option will be traded for a longer period of time than the July option. The time period from March 1 to mid July, when the August option expires, is four and one-half months. The time period from March 1 to mid June for the July option is only three and one-half months.

Call option writers (sellers) bear the risk of loss due to a price rise. They demand a higher return (premium) for bearing this risk for a longer time period, especially considering that June and July are usually periods of price volatility due to the crop growing season.

Strike Price vs. Futures Price
The extrinsic value is 29 cents for the at-the-money July $6.50 strike price option. It is only 14 cents for the 50 cents out of-the-money option ($7 strike price option) and 8 cents for the 50 cents in-the-money option ($6 strike price option). So the extrinsic value decreases as the option moves further out-of-the-money or in-the-money.

An option trader who is writing a call option for $6.50 will be liable for exercise value if the futures price increases by only one cent. However, by writing a $7 option, the futures price will have to rise by over 50 cents before the writer will be liable for exercise value. So the writer will demand a higher return (extrinsic value) for writing an at-the-money option.

Soybean Put Options – March 1

Soybean put option premiums are shown in Table 2. The strike prices and delivery months are the same as Table 1. The date on which the option quotes were taken (March 1) and the futures prices ($6.50) are also the same.

The premium relationships are similar to those of the call options of Table 1. However, the put option premiums with strike prices above the futures price contain intrinsic value while those below contain no intrinsic value. This relationship is opposite to that of the call options in Table 1. This occurs because exercising a put option places the option buyer in the futures markets selling (rather than buying) futures at the strike price. The futures position can then be offset by buying a futures contract at the lower price for a gain.

Soybean Call Options – June 1

Soybean call option premiums on June 1 are shown in Table 3. Futures prices have risen from $6.50 to $8.25 during the three month period.

The March 1 $6.50 strike price at-the-money August call option is now worth $1.84. The premium contains intrinsic (exercise) value of $1.75 ($8.25 – 6.50 = $1.75) plus 9 cents of extrinsic value ($1.84 – 1.75 = $.09). If you had purchased a $6.50 strike price August call option for 35 cents on March 1, you could now sell it for $1.84 for a gain of $1.49 ($1.84 -.35 = $1.49) not including trading costs. The at-the-money option is now the one with the $8.25 strike price, rather than the $6.50 strike price.

Market Volatility
The extrinsic value is greater on June 1 than it was on March 1. For example, the extrinsic value for the August at-the-money ($8.25 strike price) option is 44 cents rather than 35 cents that the at-the-money ($6.50 strike price) option was on March 1, even though the time value is three months less (1 and a half months to expiration vs. 4 and a half months). This is because the market is much more volatile on June 1 than it was on March 1. Because of market volatility, option writers demand a higher return to compensate them for the greater risk of loss due to a rapidly changing market.

Don Hofstrand , retired extension value added agriculture specialist, [email protected]

Ag Decision Maker, Iowa State University Extension and Outreach, Department of Economics, [email protected], 641-732-5574

Copyright © Iowa State University Extension. All rights reserved. | Policies | State & National Extension Partners | Text Only |

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