Put Options Lesson 5: Potential Value

When Does A Put Option Have No Potential Value?

Lesson 4 option lesson ended with the question, if September wheat went to $25 in June, when would the September $10 put options have no value?

Was it when the $10 put become worthless? Meaning the option could not be sold because no one would pay even a fraction of a cent for it? No.

Was it when the wheat futures hit $25? No.

No matter how high futures price goes, all put options will be “alive” until the end the lasty trading day for that option. Options on the Minneapolis Grain Exchange, KC Board of Trade and the Chicago Board of Trade all expire the month preceding the futures contract month on the last Friday of that month that is followed by at least two business days the next week. Depending on how the weekends fall, expiration day may be the third or fourth Friday, so pay attention.

What do you suppose the right to sell September wheat futures at $10 is worth on its last trading day if September wheat futures were at $6.00? This is not rocket science. This is 3rd grade math.

Yep, $4.00 a bushel. The buyer of the $10 put can 1) sell that put option for $4 or 2) exchange it for short (sold) futures position (exercise the option) or 3) walk away from it.

Even if a $10 September put option was worthless for several months in the early summer because futures went to $25, it still gave the owner the right to sell September wheat futures at $10.

Clearly, if a farmer sold September wheat futures even at the high price of $11, he would never feed his futures account $14 per bushel ($70,000 on one 5,000 bushel contract), but there was no need to liquidate a put option because the financial loss was limited to the cost of the put.

If the wheat futures price went above $18 or so in June, that $10 put market price was worthless because nobody would pay anything for it. Even though it was worthless, a September put was still viable; the right to sell at $10 was always there until the close of business on expiration day. Never forget that.

September 2022 CBOT wheat settled at $10.95¼, April 20th down 9¾ cents, so the premiums (market value) of the puts (the right to sell futures) should have increased.

Since the delta of the $10.00 put was 0.31, the premium of the $10.00 put should have moved higher by 0.31 times the futures change of 9¾ cents which = 3.0225 cents which = about 3 and 3/8 cents.

At the close on 19th of April, the $10.00 put premium was 54¾ cents. The next day, with futures down 9¾¢, the premium settlement was 55¼ cents, an increase of only half cent.

Well, shucks; that is why we say nothing is 100% in this business! The premium should have moved higher by about 3 cents!

Options values, like futures values are determined by “bid & ask”; specifically, what price is someone willing to pay for the option and what price is someone willing to sell the same option. You have all been to auctions and have seen things that sold way too low or way too high.

In any case, on April 20th, 2022, the September 2022 $10.00 CBOT wheat put gained $25 in value, which is a half cent on 5,000 bushels.

If one had a short September futures position, the profit would have been $487.50 (9¾ cents times 5,000 bushels in an option contract).

Which is better: making $25 or making $487.50?

The $9.00 September put’s premium lost a quarter cent on the 20th despite futures being down 9¾¢. Futures went down and the value of the put went down also; it is not supposed to work that way! But auctions do work that way sometimes.

The market on April 20th smelled (feels, gut feeling, intuition, instinct, etc) like a “bear trap”.

A “bear” is a person who thinks the market will move lower. The April 20th futures market action allowed bears to think they were finally right about the market going lower because the futures traded lower and settled lower than any day since April 11th. But the “trap indicator” was the options did not trade the way they should have. Turned out, it was a bear trap. A month later, September wheat traded to $12.85!

Here are the September 2022 CBOT wheat option settlements on April 20th, 2022: