basic options - opt 101
TRANSCRIPT
Basic Options
Teacher: Jeff FichtelmanOPT 101
Approximate Length: 1 hour
AdvancedFarmer.com
Table of Contents• Prerequisite Knowledge
• Basic Definitions
• Anatomy of an Option
• Basic Price Relationships
• Basic Option Strategies
• Recommended Courses
• Exam
OPT 101: Basic Options
AdvancedFarmer.com
Prerequisite KnowledgePrerequisite knowledge:• Basic understanding of grain futuresPrerequisite course suggestions:• None
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Basic Definitions• Grain Futures Acronyms• Option Contract• Long• Short• Call Option• Put Option• Options on Futures• “Moneyness”• Options Overview
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Grain Futures AcronymsBasic Definitions
• Grain Futures– “C” = Corn– “S” = Soybeans– “W” = Wheat– “O” = Oats
• Futures Months– “F” = January– “G” = February– “H” = March– “J” = April– “K” = May– “M” = June– “N” = July
• Futures Months (cont.)– “Q” = August– “U” = September– “V” = October– “X” = November– “Z” = December
• Years– “11” = 2011– “12” = 2012
• Examples– CZ11 = Dec 2011 Corn– SX12 = Nov 2012 Soybeans– WN13 = July 2013 Wheat
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Option ContractBasic Definitions
• Definition– Two Parties
• Buyer of Option• Seller of Option
– Buyer has Right to Exercise Contract– Seller is Obligated if Buyer Exercises Contract– Buyer pays Seller premium for taking on risk
• Example 1 – Option on a House• Example 2 – Car Insurance
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
LongBasic Definitions
• Definition– Makes money in a rising market– Also known as “Buyer” or “to buy”– Farmers are typically long their cash crop
OPT 101: Basic Options
Buy Price Where buyer goes “long”
Table of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
ShortBasic Definitions
• Definition– Makes money in a falling market– Also known as “Seller” or “to sell”– Farmers typically sell (go short) futures to offset their long
cash crop
OPT 101: Basic Options
Sale Price Where seller goes “short”
Table of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Call OptionBasic Definitions
• Definition– Buyer of Call:
• Right to go Long the underlying futures at the strike price• Pays seller defined premium
– Seller of Call:• Obligated to go Short the underlying futures at the strike price• Receives a defined premium
• Example – CZ11 4.50 Call @ 25c– Buyer of Call has right to go long CZ11 @ 4.50– Seller of Call is required to go short CZ11 @ 4.50– Buyer of Call pays Seller of Call 25c for Right to go Long
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Put OptionBasic Definitions
• Definition– Buyer of Put:
• Has Right to go Short the underlying futures at the strike price• Pays seller defined premium for this Right
– Seller of Put:• Is Obligated to go Long the underlying futures at the strike price• Receives a defined premium from the buyer to take on this obligation
• Example – CZ11 4.00 Put @ 15c– Buyer of Put has right to go short CZ11 @ 4.00– Seller of Put is required to go long CZ11 @ 4.00– Buyer of Put pays Seller of Put 15c for Right to go Short
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Options on FuturesBasic Definitions
• Definition– One Option Contract = One Futures Contract– Options specify which futures contract the seller will need to
provide to the buyer
• Examples– CZ11 4.50 Call
• December 2011 Corn Futures
– CK11 5.00 Put• May 2011 Corn Futures
– SN11 13.00 Call• July 2011 Soybean Futures
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
“Moneyness”Basic Definitions
• In-the-money– Calls = If Strike < Futures (Buy Low)– Puts = If Strike > Futures (Sell High)
• At-the-money– Calls / Puts = If Strike = Futures
• Out-of-the-money– Calls = If Strike > Futures (Buy High)– Puts = If Strike < Futures (Sell Low)
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Right Right
Obligation ObligationObligation
Option Overview – Part 1Basic Definitions
OPT 101: Basic Options
Call Put
Option Contract
Buy
SellOpt
ion
Tra
de
The Right or The Obligation
Right Right
Obligation
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Table of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Option Overview – Part 2Basic Definitions
OPT 101: Basic Options
Call Put
Option Contract
Buy
SellOpt
ion
Tra
deLong Short
Short Long
Long Short
Short Long
Long or Short Underlying Futures?
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Table of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Anatomy of an Option• How it’s written• Number of Contracts• Underlying Commodity • Strike Price• Call or Put• Option Premium
– Time Premium– Intrinsic Value
• Expiration Date• American Options
– vs. European Options
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
How it’s WrittenAnatomy of an Option
• +20 CZ11 4.50 Call @ 25c• +100 SX12 14.00 Calls @ 55c• -5 WN11 6.00 Put @ 30c• -15 CH12 5.00 Call @ 30c
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Number of ContractsAnatomy of an Option
• +20 CZ11 4.50 Call @ 25c• Definition
– Number of option contracts to be bought (+) or sold (-)– Equals number of underlying futures– Can not be written down by # of bushels
• i.e. +10,000 bu. CZ11 4.50 Call @ 25c (WRONG)• Note: 1 contract = 5,000 bushels (grain options on futures – C, S, W, O)
– Options can not be traded in “odd lots”• Odd Lots = increments not divisible by 5,000 (i.e. 7,500)
• Example above – Buying (“going long”) 20 contracts, or 100,000 bushels
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Underlying CommodityAnatomy of an Option
• +20 CZ11 4.50 Call @ 25c• Definition
– Defines which futures contract will be assigned to the buyer of an option
– Refer to the “Grain Futures Acronyms” slide
• Example above – December (“Dec”) 2011 Corn
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Strike PriceAnatomy of an Option
• +20 CZ11 4.50 Call @ 25c• Definition
– Defines the price at which the futures are transacted
• Example above – The buyer of this call has the right to go long December 2011
corn at $4.50– The seller of the call is obligated to go short December 2011
corn at $4.50 if the buyer exercises his/her right
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Call or PutAnatomy of an Option
• +20 CZ11 4.50 Call @ 25c• Definition
– Defines whether the option is a call or a put
• Example above – Call Option (i.e. “Call”)
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Option PremiumAnatomy of an Option
• +20 CZ11 4.50 Call @ 25c• Definition
– What the buyer of an option pays the seller• Grain Options = price per bushel (1 contract = 5,000 bushels)
– Determined by a market• Highest bid (i.e. buyer) vs. Lowest offer (i.e. seller)
– Can be calculated from a formula• Black-Scholes Option Pricing Formula (Theoretical price)• Put-Call Parity (Arbitrage price)
• Example above – 25 cents per bushel ($1,250 per contract = $0.25 x 5,000 bu.)
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Option Premium – Intrinsic ValueAnatomy of an Option
• Definition– Calls = Max (Futures – Strike, zero)– Puts = Max (Strike – Futures, zero)
• Example 1– CZ11 4.50 Call @ $0.50– CZ11 Futures @ $4.70– Intrinsic Value = Max ($4.70-$4.50, zero) = $0.20
• Example 2– CZ11 4.50 Put @ $0.30– CZ11 Futures @ $4.70– Intrinsic Value = Max ($4.50-$4.70, zero) = $0.00
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Option Premium – Time PremiumAnatomy of an Option
• Definition– Calls or Puts = Option Premium – Intrinsic Value
• Example 1– CZ11 4.50 Call @ $0.50– CZ11 Futures @ $4.70– Time Premium = $0.50 - $0.20 = $0.30
• Example 2– CZ11 4.50 Put @ $0.30– CZ11 Futures @ $4.70– Time Premium = $0.30 - $0.00 = $0.30
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Expiration DateAnatomy of an Option
• +20 CZ11 4.50 Call @ 25c• Definition
– Standard Options expire:• The last Friday preceding the first notice day of the corresponding
futures contract month by at least two business days.
• Example above – Corresponding Futures Contract Month: December 2011– First Notice Day: December 1, 2011– Option Expiration: November 25, 2011
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
American OptionsAnatomy of an Option
• +20 CZ11 4.50 Call @ 25c• Definition
– American Options can be exercised by the buyer at any time from purchase until expiration of the option contract• All standard grain options traded on the CME/CBOT are American
Options
– European Options can only be exercised by the buyer of an option contract on the expiration date
• Example above – American Option– Buyer can exercise right to go long CZ11 @ $4.50 anytime
between purchase of option contract and close of trading on November 25, 2011
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Basic Price Relationships• In a rising market• In a falling market• In a sideways market
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
In a Rising MarketBasic Price Relationships
• Starting Prices– CZ11 5.00 Call @ 60c– CZ11 5.00 Put @ 60c– Starting CZ11 Futures = $5.00– Current Date = 12/24/2010– Option expiration date = November 25, 2011
• Scenarios1. CZ11 @ $5.50 (up $0.50); in 100 days (date: 4/23/2011)
• CZ11 5.00 Call = $0.81 (up $0.21)• CZ11 5.00 Put = $0.31 (down $0.29)
2. CZ11 @ $6.00 (up $1.00); in 100 days• CZ11 5.00 Call = $1.19 (up $0.59)• CZ11 5.00 Put = $0.19 (down $0.41)
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
In a Falling MarketBasic Price Relationships
• Starting Prices– CZ11 5.00 Call @ 60c– CZ11 5.00 Put @ 60c– Starting CZ11 Futures = $5.00– Current Date = 12/24/2010– Option expiration date = November 25, 2011
• Scenarios1. CZ11 @ $4.50 (down $0.50); in 100 days (date: 4/23/2011)
• CZ11 5.00 Call = $0.27 (down $0.33)• CZ11 5.00 Put = $0.77 (up $0.17)
2. CZ11 @ $4.00 (down $1.00); in 100 days• CZ11 5.00 Call = $0.12 (down $0.48)• CZ11 5.00 Put = $1.11 (up $0.52)
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
In a Sideways MarketBasic Price Relationships
• Starting Prices– CZ11 5.00 Call @ 60c– CZ11 5.00 Put @ 60c– Starting CZ11 Futures = $5.00– Current Date = 12/24/2010– Option expiration date = November 25, 2011
• Scenarios1. CZ11 @ $5.00; in 100 days (date: 4/23/2011)
• CZ11 5.00 Call = $0.50 (down $0.10)• CZ11 5.00 Put = $0.50 (down $0.10)
2. CZ11 @ $5.00; in 200 days (date: 7/12/2011)• CZ11 5.00 Call = $0.38 (down $0.22)• CZ11 5.00 Put = $0.38 (down $0.22)
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Basic Option Strategies• The P/L Chart• Long Call Option• Long Put Option
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
The Profit & Loss (P/L) ChartBasic Option Strategies
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Long Call OptionBasic Option Strategies
OPT 101: Basic Options
Long CZ11 5.00 Call @ 65c (CZ11 = 5.00)Scenario = 167 days from now (halfway until expiration)
Long @ 5.00
Long Futures Long CZ11 5.00 Call @ 65c
Market Price = 5.00
Break-even @ 5.65
Max loss = 65cMax loss = 5.00
Max gain = ∞Max gain = ∞
Table of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Long Call OptionBasic Option Strategies
OPT 101: Basic Options
Long CZ11 5.00 Call @ 65c (CZ11 = 5.00)Scenario = 167 days from now (halfway until expiration)
Table of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Long Call Option (different strikes)Basic Option Strategies
OPT 101: Basic Options
Long CZ11 5.00 Call @ 65c (Strategy 1)Long CZ11 6.00 Call @ 40c (Strategy 2)
Table of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Long Put OptionBasic Option Strategies
OPT 101: Basic Options
Long CZ11 5.00 Put @ 65c (CZ11 = 5.00)Scenario = 167 days from now (halfway until expiration)
Short @ 5.00
Short Futures Long CZ11 5.00 Put @ 65c
Market price = 5.00
Break-even @ 4.35
Max gain= 4.35
Max gain = 5.00
Max loss = ∞ Max loss = 65c
Table of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com
Long Put OptionBasic Option Strategies
OPT 101: Basic Options
Long CZ11 5.00 Put @ 65c (CZ11 = 5.00)Scenario = 167 days from now (halfway until expiration)
AdvancedFarmer.com
Table of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
Recommended CoursesPrerequisite Course Suggestions:• NoneRecommended Next Courses:• OPT 201: Intermediate Options• OPT 301: Advanced OptionsOther Complementary Courses:• EXL All: Learning the Excel Models• FRM All: Any Farmer Specific Courses• SPC All: Any Grain Speculator Courses• TCA All: Any Technical Analysis of Grain Market
Courses
OPT 101: Basic OptionsTable of Contents
Prerequisite Knowledge
Basic Definitions
Anatomy of an Option
Basic Price Relationships
Basic Option Strategies
Recommended Courses
Exam
AdvancedFarmer.com