Derivatives Lecture 20 Futures Options Overview A Futures

Derivatives Lecture 20

Futures Options Overview A Futures Contract on an Option ◦ The underlying asset is not a stock ◦ The underlying asset is a futures contract Call Futures Option ◦ Long Call = The right to long a futures contract ◦ Short Call = The obligation to short a futures contract Put Futures Option ◦ Long Put = The right to short a futures contract ◦ Short Put = The obligation to long a futures contract

Futures Option Specifications Futures Options = FO No delivery occurs Commodities are Settled in Cash Financials might take delivery One option = one futures contract Expiration ◦ Financial options Same date as futures contract expiration ◦ Commodity Options Expire the month prior to the futures contract expiration

Futures Options Pricing FO prices are listed in “units” Each “Unit” has a $ value Example (Corn FO) Underlying asset = 5, 000 bushels of corn Price quoted in cents per bushel ◦ 1 unit = $50 ◦ 1/8 of a unit = $6. 25 (on 1/8 cents per bushel) May 3600 Call = 20’ 3 ◦ 20 x$50 + 3 x$6. 25 = $1, 018. 75 The strike of 3600 = $3. 60 or 360 cents per bushel CME lists details

Futures Options Example (Soybean FO) September soybean futures are selling for 1049 cents per bushel The underlying asset is one futures contract on 5, 000 bushels of soybeans as listed on the CBOT The value of one futures contract ◦ 5000 x $10. 49 = $52, 450 The unit value is $50 ◦ Determined 5000 x. 01 = $50 The futures option price is quoted in Units and ticks ◦ (ticks are 1/8 cents per bushel or $6. 25) But the total price is ($50 x cents + $6. 25 x ticks)

Futures Options Example (Soybean FO) - continued Sept 1040 P = 42’ 2 total cost=($50 x 42)+($6. 25 x 2) = $2, 106. 50 Sept 1040 C = 53’ 2 $2, 565. 50 Sept 1120 C = 26’ 4 $1, 325. 00 BE Soybean Price on Sept 1120 C= 1120 + 26’ 4 = $11. 465 per bushel BE Contract Value on Sept 1120 C = $56, 000 +$1325 = $57, 325. 00

Futures Options Units Vary depending on the underlying asset Each asset has a unique relationship among ◦ Asset price ◦ Futures Contract specs ◦ Option Basic Underlying Asset Categories Commodity Financial Currency others

Futures Options Example - gold is quoted in $ per ounce Example - Sugar is quoted in cents per pound CME web site Pricing – Same as regular options. Black Scholes Binomial

Futures Options FO Margin Determined by volatility and risk of loss Futures Options use unique margin accounting SPAN= Standard Portfolio ANalysis of Risk Futures Options Uses Same as futures w/ flexibility Floors, ceilings, spreads, etc Employs all Option strategies Arbitrage (lots of mispricing)

Futures Options Strategies Class Brain storm