Put Options Lesson 13: Practical Application part 2

CBOT September 2022 wheat was up 45½¢ the week ending July 8^th. Since the futures price was up, the puts with strike prices within a few dollars of the futures price decreased in value. Why?

The higher the futures price moves, the less value a put has because a put gives its owner the right to sell something and if the price of that something increases, the value of selling it at fixed strike price diminishes.

For example, on July 1^st, September wheat settled at $8.46. The $9 put gives the buyer of the option the right to sell September wheat futures at $9.00. When the futures price is $8.46, the $9.00 put was 54¢ in-the-money, meaning, if the option was exercised (exchanged for a futures contract sold at $9.00), the resulting futures position would have 54¢ profit. But on July 8^th, with September wheat at $8.91½, was just 8½¢ in-the-money. Most people would rather own an option 54¢ in-the-money than an option 8½¢ in the money. What about you?

Below on the left are some September put options and their values on July 1^st when September wheat was at $8.46 and, on the right, the same strike price puts and values on July 8^th when September wheat was at $8.91½.

Option values are called “premiums” and they are listed in cents per bushel down to an eighth of a cent. A premium of 88-5 is 88 and five-eighths cents per bushel of option. There are 5,000 bushels in one option, the same as a futures contract, which makes sense since options are the right to buy or sell a futures contract.

A hedge in one’s own hedging account or as a HTA with a merchandiser, each 5,000-bushel contract lost $2,725 this past week. The value of the wheat in the bin or in the field gained about the same +/- basis. That is text-book how a hedge works.

The September $9.00 put lost 22-5¢ per bushel and $1132.5 per option.

The September $10.00 put lost 31-7¢, $1,593.75 per option.

The $10 put lost more premium than the $9 put because its strike price of $10 was closer to the futures price than the $9.00 put. One could say the $10 put was more sensitive to price changes than the $9.00 put. That sensitivity is measured by the delta. The delta of each option is in the chart.

If an option has a delta of .48, that means the price of the option is expected to change 4.8 cents for each ten-cent change in the futures contract price. However, as you know, nothing is 100% in this business. The futures price and the option price are both derived independently of each other by an auction.

In this series of put lessons, we have several example farmers using different combinations of marketing tools to price their 2022 wheat:

Dan contracted wheat at $11.00 on a HTA and bought the $9 and $10 puts for 29 cents each.

Joe contracted wheat at $11.00 on a HTA and bought the $10 and $11 puts for 59 cents each.

Don, who did not sell the futures, but bought a $9 put for 29 cents and then, when the futures gained a dollar, he bought a $10 put for 29 cents.

Junior, who did not sell futures, but bought the $10 put for 59 cents and then bought the $11 put for 59 cents.

Dan and Joe are using the HTA as their primary marketing tool and the puts as a price enhancer.

Don and Junior are using the put options as the primary marketing tool. Can they use the HTA also? Yes, but will they? What could happen that would motivate them to use a HTA?