your best result comes from much higher prices and maximizing the value of

Your best result comes from much higher prices and

This preview shows page 151 - 154 out of 212 pages.

your best result comes from much higher prices and maximizing the value of soybeans growing in the field. The put options simply serve as price insurance and, like auto insurance, a driver is better off without accidents and payouts. As we’ve done with earlier examples, it might help to “unwind” this hedge at harvest under three different price scenarios: flat prices (November futures do not change), lower prices and higher prices.
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152 Applied Economics 3411/5411, 2018 Lecture Notes Copyright © 2018 Edward Usset. All rights reserved. The flat price (no change in November futures) scenario… Buy put options to establish a minimum price on grain before harvest Date Cash Options Basis/Min. Price April Planting starts soon and a producer wants to establish a minimum price for soybeans at harvest With November futures trading at $10.00, buy Nov 1000 puts for 61 cents/bu. Expected harvest basis is -$0.75, or 75 cents under the November contract. Min. expected price: 10.00 strike + (-.75) basis – .61 premium – .01 fees = $8.63 Late September harvest Sell newly harvested soybeans for $9.28 Nov futures at $10, sell 1000 puts for ??? Actual basis is 72 cents under ($9.28 cash - $10.00 futures) Can we calculate the actual price received for soybeans at harvest? Not yet. The November options purchased earlier will expire in mid-October. These puts will have some value remaining, but probably not much (5-15 cents?). Should the puts be sold on the same day that soybeans are harvested and sold? Another good question and the answer depends on the producer’s market opinion. However the producer chooses to dispose of the options (sell now, or wait 3 weeks for expiration?), the final price will be close to the minimum established in April: $8.63/bu. That was the flat price scenario. Let’s run through a different scenario. This time, the growing season proved to be less than ideal and soybean production suffered. Less production means less supply and higher prices.
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153 Applied Economics 3411/5411, 2018 Lecture Notes Copyright © 2018 Edward Usset. All rights reserved. The higher price scenario… Buy put options to establish a minimum price on grain before harvest Date Cash Options Basis/Min. Price April Planting starts soon and a producer wants to establish a minimum price for soybeans at harvest With November futures trading at $10.00, buy Nov 1000 puts for 61 cents/bu. Expected harvest basis is -$0.75, or 75 cents under the November contract. Min. expected price: 10.00 strike + (-.75) basis – .61 premium – .01 fees = $8.63 Late September harvest Sell newly harvested soybeans for $10.53 November futures at $11.25/bu., let the 1000 puts expire worthless Actual basis is 72 cents under ($9.28 cash - $10.00 futures) As prices trend higher, the value of a put option decreases. Why would anyone value the right to sell soybeans at $10/bu. when the market is trading at $11.25/bu.?
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