Put Options Lesson 4: No Margin Calls
- Wright team
- 7 days ago
- 3 min read
September CBOT wheat settled at $11.05 on 19 April 2022, down 18¼ cents. The previous day, that wheat futures price was up 22¼ cents, so the premiums of the puts were down on 18 April 2022. The lower futures price increased the value of all puts on the 19 April 2002.
A put option gives the buyer the right to sell futures at a set futures price, aka the strike price. As the futures price moves lower, every put option increases in value.
The September 2022 $10 put gained $237.50 of value on the 19th. If one had a short September futures position that day, he would have made $912.50. Which is better: making $237.50 with a put option or making $912.50 with a futures contract?
No brainer, but there are other factors to consider. The big one being the owner of a put will never be asked to add money to maintain his option position. A short futures position could require an unlimited amount of additional money because each day the futures price closes higher, the price change in cents per bushel is transferred from the futures account which sold futures (short position) to the futures account which bought futures (long position).
Let’s say the futures price goes to $25 the first week of June like spring wheat futures did in February 2008. From the 19 April 2022 settlement of $11.05 to $25 is $13.95 per bushel loss times 5,000 bushels per contract = $69,750 of loss which must be replaced in the futures account penny for penny every day all the way up if one maintains that short futures position.
You already know the buyer of a put will never have to add money to his options account to maintain his option position. What do you suppose the right to sell September wheat at $10 would be worth when the September futures price is at $25 the first week in June?
Not much, maybe a quarter of a cent, because few people would pay money for a September $10 wheat put that expires on 26 August 2022 with September wheat at $25 In June.
In such a case, someplace in that price rally, a farmer or his banker will decide a short September wheat futures position needs to liquidated to stop the mounting losses and the margin calls. Let’s say a liquidation is done as $15.05. So, the loss on the futures position liquidated at $15.05 is $5 per bushel or $25,000 for each futures contract. Ouch!
The worst that can happen to a buyer of an option is the buyer loses 100% of his investment, but no more.
If a wheat farmer had sold the futures and then liquidated at $15.05, he desperately wants the price of wheat to continue higher. The worst thing that could happen to him is he loses money all the way up in the futures market, liquidates his short position at a loss and then wheat futures price goes down to $6, where he might be selling his cash (physical bushels of) wheat.
He then subtracts his futures loss from the cash price he received for his wheat and there will not be very much left over. A sad story indeed and that is why we never recommend buying back a HTA or a Forward Contract when a futures price is making multi year highs. Grain merchandisers, as all futures traders know, it is possible for anyone to run out of money, including Cargill. Read about futures liquidation during the 1988 drought:
Ok, here is a question for you to ponder: If the September futures price goes to $25 in early June and then to $6 in late August, when did that $10 September 2022 wheat put option become absolutely, positively worthless?
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