Basic Mechanics of Agricultural Options

There are two types of options: calls and puts. A call option is a financial instrument that increases in value if the underlying commodity increases in price (e.g. corn options track the price of corn). A call essentially gives you the right to buy the underlying commodity at a specific pre-determined price (strike price) at any time within a certain time frame (before expiration). A put option works the same way, except it is for the opposite price direction. If the price of a commodity falls, a put option increases in value. A put gives you the right to sell something at a specific pre-determined strike price before expiration.

The most important basic parts to an option:

Commodity/Underlying Market

• E.g. Corn, Wheat, Soybeans

Time Until Expiration

• The last day an option can be traded.
• The option will trade until the third or fourth Friday in the month before the expiration month. Thus, a December Wheat option will expire in November.

Strike Price

• The price at which the buyer of a call (put) can exercise their right to buy (sell) the underlying futures contract (e.g. $5.00, $5.10, $5.20, etc. corn call)

Amount Controlled

• Each contract controls a specified amount of a commodity (e.g. corn, wheat, and soybeans all control 5,000 bushels per contract)

Premium Price

• The price that options can be bought and sold for on the open market
• Each penny ($0.01) in the corn, wheat, and soybeans equal $50. Thus, if you purchase a put for 10 cents, it costs $500 ($50/cent x 10 cents) + commission and fees.

It is important to understand that every call option has a buyer and seller — a buyer of the call and a seller of the call. Likewise, a put option has a buyer and seller. The key difference is this: buyers are holding the rights held within the option contract and sellers are offering the rights held within the option contract.

Example:

Any trades are educational examples only. They do not include commissions and fees.

Corn Call Buyer pays 20 cents ($1,000) = Corn Call Seller collects 20 cents ($1,000)

• Corn Call Buyer makes money if they can sell it for more than 20 cents
• Corn Call Seller makes money if they can buy it back for less than 20 cents or option expires worthless

Corn Put Buyer pays 30 cents ($1,500) = Corn Put Seller collects 30 cents ($1,500)

• Corn Put Buyer makes money if they can sell it for more than 30 cents
• Corn Put Seller makes money if they can buy it back for less than 30 cents or option expires worthless

Standard options have the same contract month as the underlying futures contract. For example, if a farmer exercises a $6.00 December Corn Call, they will be assigned a long futures position at $6.00 in the December futures contract. There are also serial options or short-term options that are traded in months that do not have a futures contract. For example, if you exercise a $6.00 June Corn Call option, you will receive a long futures position at $6.00 in the July contract.

Options are traded the same way that futures contracts are traded. All buying and selling occurs through a competitive trading on the exchange.

Some Basic Options Facts to Remember

• You can buy/sell an option just like a stock or futures contract. As long as the market is open, you look to initiate or liquidate a position. You are not locked into the trade until expiration.
• Remember that everything is standardized for an options contract except the “premium price” as it fluctuates based on supply and demand. Standardization includes the commodity, call/put, time until expiration, and strike price.
• When you buy a $6.00 December Corn Call, in order to liquidate it, you must sell a $6.00 December Corn Call. Likewise, if you purchased a $10.00 March Soybean Put, in order to liquidate, you must sell a $10.00 March Soybean Put.
• Purchasing a Call/Put option has no margin requirement as your maximum risk is limited to the premium you pay for the option.
• Selling (otherwise known as writing) a Call/Put is when a trader initiates an option trade by selling it first to collect the premium. Since the trade is “short the option”, it requires a margin with the exchange since your risk is theoretically unlimited.