Put Options Lesson 6: Writing an Option

On April 21st, 2022, September 2022 CBOT wheat futures settled 20 cents lower at $10.75¼.

The $10 September wheat put option premium should have increased 6½ cents (delta times 20 cents). However, it increased about half that much. See the price chart below.

The $9 September put premium should have increased by a little more than 3½ cents (delta times 20 cents), but it lost a quarter cent!

Clearly, the option traders are bullish wheat and many traders realized that the big spec funds were trying to muscle the May futures lower by the close to make as many call options as possible expire worthless.

Why do big spec traders want to make as many call options as possible expire worthless? Most of the options bought are by small traders and they buy them from mostly the big spec funds, who are comfortable taking the margin call risk of writing an option.

Writing an option is selling an option to establish a market position. Writing an option is selling an option that has not been previously purchased. Options writers are short the option. They want the value of the option to decline so they can buy it back at a lower price than they wrote (sold) it for or, better yet, they want the option to expire worthless so the writer of the option does not need to buy it back at any prices.

How does an option expire worthless? We had a client wrote a CBOT May $20 call for 38 cents a bushel the day the war started (February 24th). In exchange for 38 cents, he was giving the buyer the right, without the obligation, to make our client sell him May wheat futures at $20 any day until May options expired, which was on April 22nd.

As it turned out, May wheat settled at $10.65½ on expiration day. Do you think the guy that paid 38 cents for right to buy May wheat at $20 wanted to buy May wheat at $20 or would he rather buy it at $10.65½? Yep. So the May $20 call expired worthless and the writer (our client) kept all of the 38 cents he received for writing the $20 call option on February 24th.

Usually, there are twice as many calls on the books (open interest) as puts. People who buy options just cannot get comfortable buying something (a put) and wanting the futures price to go down. Therefore, non-professional traders buy twice as many call options as they do put options. Professional traders seldom buy call options because they know they are a poor investment.

The big spec funds want to push the futures price down as far as possible the few days before the options expire because they wrote twice as many calls as they did puts. Ideally, on option expiration day, they want the settlement futures price to be dead on a strike price so both the calls and the puts at that strike price expire worthless.

Pay attention to this:

• All option buyers have limited financial risk and unlimited financial gain opportunity.

• All option writers (sell before they buy) have limited profit potential and unlimited financial risk.

And that, Ladies and Gentlemen, is why the options are so expensive. We began applying writing options as part of our market plan for our clients who can grasp the concept of writing options. For example, a corn farmer has corn to sell. Most year’s $7 at harvest is a good price for corn. We have a client who wrote 40,000 bushels of $7.00 December 2022 corn calls in April 2022 and received 58¢ per bushel through his grain merchandiser.

Let this soak in: Somebody paid a farmer 58¢ a bushel in April 2022 for the right to make that farmer sell him 40,000 bushels of December 2022 corn futures as a $7.00 HTA through his merchandiser.

No matter what the market does, the farmer keeps the 58¢ if he hangs on to the position until expiration day, November 25th. The farmer may or may not have to sell his corn at $7.00 HTA.

Since the farmer sold and delivered 40,000 bushels of old crop corn, his merchandiser wrote the $7 December calls and added 58¢ to the cash price of the old crop corn delivered in April.

You could have done the same thing. If you have old crop corn, you can still have value added to your selling price by writing December call options. The $7.00 calls today (May 26, 2022) are at 75¢; the $8 calls are at 41¢ a bushel.

How many of you are ready to learn more about options?

We recommended clients with July 2022 wheat HTA contracts in the $8.00 range buy either the September $9.00 wheat puts for 20¢ or the $10 put for 60¢. Below is the chart of CBOT wheat put option settlements for April 21, 2022 when September SRW wheat settled at $10.75¼: