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Unformatted text preview: er a put or
call option? Futures and
Options Key Terms
option Futures futures contract
Agreement to buy or sell
a specific amount of
instrument) at a particular price on a stipulated
future date. Myers is a miller. He buys wheat from the
wheat farmer, turns the wheat into flour, and
then sells the flour to the baker. Obviously he
wants to earn a profit for what he does. But
how much, if any, profit he earns depends on
the price at which he can buy the wheat, and
the price at which he can sell the flour.
Now suppose Myers enters into a contract with a baker. Myers promises to deliver
to the baker 1,000 pounds of flour in six
months. At the current wheat price, $3 a
bushel, Myers knows he can earn a profit on
his deal with the baker. But he doesn’t need
the wheat now; he needs it in about 6
months. What will the price of wheat be
then? If it is, say, $2 a bushel, then Myers will
earn more profit on the deal with the baker.
But if it is, say, $4 a bushel, then he will lose
money on the deal. Myers’s problem is that
he doesn’t know what a bushel of wheat will
sell for in six months.
Myers decides to enter into a futures contract. A futures contract is a contract in
which the seller agrees to provide a particular good (in this case, wheat) to the buyer on
a specified future date at an agreed-upon 450 Chapter 16 Stocks and Bonds price. For example, Myers might buy bushels
of wheat now, for a price of $3 a bushel, to
be delivered to him in six months.
Who would enter into a futures contract
with Myers? A likely possibility would be a
speculator, someone who buys and sells commodities to profit from changes in the market.
A speculator assumes risk in the hope of making a gain.
Suppose Smith, a speculator, believes that
the price of wheat six months from now is
going to be lower than it is today. She may
look at things this way: “The price of wheat
today is $3 a bushel. I think the price of
wheat in six months will be...
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- Winter '14