In this scenario we can calculate the actual price received for soybeans at

In this scenario we can calculate the actual price

This preview shows page 153 - 156 out of 212 pages.

In this scenario, we can calculate the actual price received for soybeans at harvest. Simply take the cash price received at harvest ($10.53) and subtract the premium lost on the put option ($0.61) and the fees ($0.01). $10.53 cash price – 0.61 premium – 0.01 fee = $9.91/bu. Let’s finish with a final scenario of a bumper crop, large supplies and lower prices at harvest.
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154 Applied Economics 3411/5411, 2018 Lecture Notes Copyright © 2018 Edward Usset. All rights reserved. The lower 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 $8.15 November futures at $8.87, sell puts Actual basis is 72 cents under ($9.28 cash - $10.00 futures) As prices trend higher, the value of a put option increases. These puts are $1.13 in-the-money (10.00 strike – 8.87 price). The 1000 put options will be worth at least the intrinsic value of $1.13, and possibly a penny or two more. By the way, that $1.13 is not all profit – the producer paid $0.61 for the put. The profit on the put option is $0.52/bu. (1.13 – 0.61). The result is a final price close to the minimum. In this lower price scenario, let’s calculate the actual price received for soybeans at harvest. Simply take the cash price received at harvest ($8.15), add the gain from the put option ($0.52) and subtract fee ($0.01). $8.15 cash price + 0.52 gain on puts – 0.01 fee = $8.66/bu. The final price is 3 cents higher than our expected minimum because the basis was 3 cents better than expected. Futures vs options – summary : With a futures hedge in this example, the producer is heading towards a price of $9.24/bu. at harvest, with no upside potential. By using put options, the worst-case scenario (aka minimum price) is about $8.63/bu. at harvest, with unlimited upside potential. However, two of three price scenarios (flat and lower) lead to the minimum price, or worst-case scenario. Only a higher price scenario will help.
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155 Applied Economics 3411/5411, 2018 Lecture Notes Copyright © 2018 Edward Usset. All rights reserved. Long hedge alternative – buying call options For grain buyers (e.g., livestock producers), an alternative to a basic long hedge is buying call options to establish a maximum price on grain to be purchased. In this segment, we will explore the purchase of call options to establish a maximum price. Buying call options establishes a maximum price, sometimes called a ceiling price. Here’s a simple equation to calculate a maximum price established by buying call options… call strike price + expected basis + premium + fees = expected maximum price This is an expected price, based on the expected basis. The actual basis will probably be a little different from expectations. It is also important to remember that basis is often a negative number.
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