Roger, If I bought a March corn put for 12 cents, how far can market go up before that is worthless?
As long as an option has not expired, meaning it could still be bought, sold or exercised, there is a possibility it will increase in value, even from zero value.
Let’s say Jim bought a March 2022 $5.30 corn put on October 29th, 2021 at a cost of 12 cents when March 2022 corn futures were at $5.76. With that put, Jim bought the right, but not the obligation, to sell March 2022 corn futures for $5.30 any business day he wants between the end of October 2021 and the close of CBOT business on February 18th, 2022, when the March 2022 CBOT options expire.
On Monday, Nov 1st, March 2022 corn settled up 10¾ cents. Jim’s March $5.30 put settled at 8½ cents.
Since I am writing this after the close on November first and nobody knows what the price of corn will do, let’s say March corn goes to $7.50 by the end of November. If that actually happened, the right to sell March corn at $5.30 (a $5.30 put option) will be worth one-eighth of a cent. Why?
Because with March 2022 corn at $7.50, the market thinks the chance of March 2022 corn dropping more $2.20 (to go below $5.30) by the 18th of February is nil. Is that the same as worthless? Pretty close, yep.
Let’s say by the middle of December, March corn is $8.50. Jim contracts his 50,000 bushels of corn at the ethanol plant. The value on the quote screen will say the value of the March $5.30 put is still one-eighth of a cent because the option still has two months of life. But who will pay the commission plus an eighth cent to buy a put option $3.20 out of the money? No one.
So, the option is worthless because no one will buy it. However, that option is still alive because it does not expire until February 18th 2022.
If Jim had sold March futures at $5.30 and held onto that futures position all the way up $8.50, his total margin call would have been the difference between his selling price ($5.30) and $8.50, or $3.20. Why?
Because when a short (sold first and buy later) futures position is established, the seller has the right and the obligation to sell March corn futures at $5.30.
But Jim bought a March $5.30 put option which gave him the right, but not the obligation to sell March corn at $5.30. The most Jim can lose on his option is the 12 cents he paid for it because he is not obligated to sell March corn at $5.30.
So, March corn is at $8.50 in mid-December and the $5.30 March put is worthless. Jim is really happy he lost that 12 cents a bushel on those $5.30 put options. Why? The reason he lost money on the put options was because the price of corn was above $5.30 and Jim had 50,000 bushels in his bin worth a lot more than $5.30 by December.
He bought the put as price insurance for his corn in the bin. With March corn at $8.50, he is smiling ear to ear.
What about his $5.30 put? With March corn at $8.50, nobody is going to buy it. Come on, think about it. Who would pay money for the right to sell March corn futures at $5.30 with the March futures at $8.50 in December?
So, Jim forgets about it. He cut a fat hog when he sold his corn at $8.50 and he does not care about his price insurance policy because he sold his corn; he has no market risk!
Three days later, Joe Biden suspends all ethanol operations for six months to give the American people a Christmas present of cheaper food. Jim realizes he just dodge a bullet. When Jim takes his corn check to the bank, his banker tells him he is the best marketer of all his clients. Jim just nods his head.
About 1 PM on February 18th, 2022, Jim’s broker calls him, “Jim, what do you want to do you with those 50,000 bushels of March $5.30 puts?”
Jim asks, “I don’t know. I thought they were worthless. You told me they were worthless.”
His broker says, “When March corn was at $8.50, your March $5.30 puts were worthless. Now that March corn $3.60, those $5.30 puts are worth $1.70 a bushel. What do you want to do with them?”
Jim asked, “What are my choices?”
“You can exercise them and be short March futures at $5.30 with a $1.70 profit or you can sell the options for $1.70.”
Jim is really confused. He was told those puts were worthless. He did not realize there was a difference between worthless and expired. The March 2022 options were viable (alive) until expiration when CBOT closes on February 18th.
Was Jim unprotected on a price drop when the options were worthless?
Yes and no. Jim was unprotected for the decline from $8.50 to $5.30, but everything under $5.30 was 100% protected. After Jim sold his cash corn, he did not need the protection of a price decline the puts provided.
If a worthless option has not expired, it can increase in value. So don’t forget there is a huge difference between worthless and expired. All CBOT options expire the calendar month before futures month on the last Friday still followed by two business days the next week. Some months that will be the third Friday and some months that will be the fourth Friday.