Strike prices are listed at predetermined price levels for each commodity: every 25 cents for soybeans, and 10 cents for corn. If you have already purchased an option, you can offset this position by selling another option with the same strike price and delivery month. If you have written (sell) an option, you can offset this position by buying an option with the same strike price and delivery month.
The buyer of a call option will make money if the futures price rises above the strike price. The seller of a call option loses money if the futures price rises above the strike price.
If the futures price drops below the strike price, the option buyer will not exercise the option because exercising will create a loss for the buyer. The buyer of a put option will make money if the futures price falls below the strike price.
The seller of a call option loses money if the futures price falls below the strike price. If the futures price rises above the strike price, the option buyer will not exercise the option because exercising will create a loss for the buyer. The intrinsic value is the amount of gain that can be realized if the option is exercised and the resulting futures position closed out.
Extrinsic (extra) value is the amount by which the option premium exceeds the intrinsic (exercise) value.
Below are examples of call and put options that are in-the-money, at-the-money, and out-of-the-money. Below are actual examples of soybean option premiums for various strike prices and delivery months. The options with strike prices at-the-money and out of-the-money have premiums containing no intrinsic value (exercise value.) Only those options that are in-the-money have premiums with intrinsic value. This occurs because the August option will be traded for a longer period of time than the July option. An option trader who is writing a call option for $6.50 will be liable for exercise value if the futures price increases by only one cent.
But if you’re familiar and understand how a particular instrument works, you can use them in specific situations with little risk to boost your investment returns in a short period of time.
But that’s beyond the scope of this article, instead we will discuss how ‘old, boring’ value investors can use put options as well to increase their investment returns.
If you buy a put option, it gives you the option to sell a stock at a certain price (strike price) before the option expires. For example, you buy a put option that gives you the option to sell XYZ stock at $50 before the option expires.
So on the other side of the coin, if you sell a put option, you are obligated to buy the stock at the strike price if the option holder chooses to exercise his option.
For example, you sell a put option that gives the buyer the option to sell XYZ stock at $50. The fact is, most options expire worthless and option sellers can collect a decent amount of cash premiums selling options (provided they understand their risk and exposure when doing so).
You can now continue to sell put options and collect cash premiums repeatedly until one day ABC stock eventually hits your target price and the option is exercised. Buffett did the same thing again for his investment in the railway company, Burlington Northern Santa Fe.
As you can see, selling put options is a great way to generate cash income and boost your investment returns. Go learn and get familiar with how options work, option chains, strike prices, expiration dates, implied volatility, and the Greeks. Like my analogy earlier, make sure you know how to drive a car before you head down the freeway!
This information should not and cannot be construed as or relied on and (for all intents and purposes) does not constitute financial, investment or any other form of advice.
Adam Wong is the editor-in-chief of The Fifth Person and author of the national bestseller Lucky Bastard!
If the rise is more than the cost of the premium and transaction, the buyer has a net gain. If the rise is more than the income from the premium less the cost of the transaction, the seller has a net loss. In this situation the option buyer will let the option expire worthless on the expiration day. If the decline is more than the cost of the premium and transaction, the buyer has a net gain.
If the decline is more than the income from the premium less the cost of the transaction, the seller has a net loss. In this situation, the option buyer will let the option expire worthless on the expiration day.
The option buyer pays the premium to the option writer (seller) at the time of the option transaction. A call option has intrinsic (exercise) value if the futures price is above the strike price.
Extrinsic value is the return that option writers (sellers) demand in return for bearing the risk of loss from an adverse price movement. These option terms pertain to the relationship between the current futures price and the strike price. In other words, a call option is in-the-money if the current futures price is above the strike price because it can be exercised at the strike price and sold at the current futures price for a gain. A one cent change in the future price will put the option either in-the-money or out-of-the-money. The time period from March 1 to mid July, when the August option expires, is four and one-half months. They demand a higher return (premium) for bearing this risk for a longer time period, especially considering that June and July are usually periods of price volatility due to the crop growing season.
It is only 14 cents for the 50 cents out of-the-money option ($7 strike price option) and 8 cents for the 50 cents in-the-money option ($6 strike price option).
However, by writing a $7 option, the futures price will have to rise by over 50 cents before the writer will be liable for exercise value. And it is true – if you don’t understand options (or any other financial instrument for that matter), you best stay away from them!
But if you do know how to drive a car, your risk goes down substantially and it can help you reach your destination much faster. In doing so, the buyer (option holder) pays a cash premium to the seller (option writer) for the option. So if you own XYZ stock and the market price falls to $45, your option allows you to sell the stock at $50 giving you a better deal. The option holder decides to exercise his option and you’re now obligated to buy ABC stock at $80.
In that time period, you boosted your overall returns by collecting cash premiums many times before you finally purchased your value stock.
As you can see, selling put options can be a very useful strategy if you’re a hard-core value investor. If the stock falls to the strike price (or below) and the option is exercised, you must have the cash ready to buy the stock. The stock you’re writing the put option for shouldn’t drop drastically in price for any foreseeable reason. Now if you want to use put options as part of your investment strategy, it is critical you understand options fully before you jump into them. If you want the stability and security of a blue-chip company but are looking for the supercharged returns of smaller, high-growth stocks, then we want to tell you that it is possible. So if I plan to sell put options, I must be looking to own at least 100 shares of the underlying stock if exercised.
But if it was GOOG, then 100 shares would cost $54,000 which might be too large an allocation for certain portfolios. A message that sound investment knowledge, financial literacy and intelligent money habits can help millions of people around the world achieve financial security, freedom and lead better lives for themselves, their family and their loved ones. The option seller (writer) must take the opposite side of the option buyer’s futures position. For example, if you choose a soybean option with a strike price of $7 per bushel, upon exercising the option you will buy or sell futures for $7. For example, corn options have December, March, May, July, and September delivery months, the same as corn futures. The amount of gain or loss from the transaction depends on the premium you paid when you purchased the option and the premium you received when you sold the option, less the transaction cost. The amount of gain or loss from the transaction depends on the premium you received when you sold the option and the premium you paid when you repurchased the option, less the transaction cost.
The seller (writer) of the call option must sell futures (take the opposite side of the futures transaction) if the buyer exercises the option. The only money transfer will be the premium the option buyer originally paid to the writer. The writer (seller) of the put option must buy futures (take the opposite side of the futures transaction) if the buyer exercises the option. The only money transfer will be the premium the option buyer originally paid to the seller. A put option has intrinsic (exercise) value if the future price is below the strike price. Conversely, a put option is out-of-the-money if the current futures price is above the strike price.
In parentheses are the intrinsic (exercise) value and the extrinsic value for each option premium.
Futures price would have to rise by over 50 cents before the option would contain any exercise value.
The time period from March 1 to mid June for the July option is only three and one-half months. So the extrinsic value decreases as the option moves further out-of-the-money or in-the-money. So the writer will demand a higher return (extrinsic value) for writing an at-the-money option.
The date on which the option quotes were taken (March 1) and the futures prices ($6.50) are also the same.
There are many successful options traders out there and you need to have a good understanding of options and its strategies to be really good at options trading.
If XYZ stock falls to $45 and the option holder exercises his option, you are now obligated to buy the stock at the agreed price of $50. You still don’t own ABC stock because it is overpriced and you collected a nice cash premium for ‘doing nothing’.
Buffett sold 50,000 contracts (5 million shares) of Coca-Cola put options with at strike price of $35 and collected $7.5 million in cash premiums upfront.
If you sell more put options than you can cover, that is extremely risky because if the options are exercised you are now obligated to buy shares beyond what you can afford. If a stock crashes, you’re now stuck with buying a stock at a huge premium when the option is exercised.
Because this is the same exact formula we used to create 7-figure results in a single stock portfolio - and we did it in just two years. We hope that the good stuff we have here will lead to smarter, more profitable investment decisions for you and the world at large. For example, if you buy an option with the right to buy futures, the option seller (writer) must sell futures to you if you exercise the option. Option contracts are traded in a similar manner as their underlying futures contracts.
However, you run the risk of having the option exercised by the buyer before you offset it.
Because of extrinsic value, an option buyer can sell an option for as much or more than its exercise value. If this option is exercised, the option buyer will own a futures contract purchased at a strike price of $6. This is where your fundamental analysis comes in and you’re sure that you’re picking a stock that’s safe, solid, and reliable.
You are advised to perform your own independent checks, research or study; and you should contact a licensed professional before making any investment decisions. All buying and selling occurs by open outcry of competitive bids and offers in the trading pit. The option writer (seller) takes the opposite side (sell) of the futures position at the strike price.
The premium is the maximum amount the option buyer can lose and the maximum amount the option seller can make.
This occurs because exercising a put option places the option buyer in the futures markets selling (rather than buying) futures at the strike price.
Because of market volatility, option writers demand a higher return to compensate them for the greater risk of loss due to a rapidly changing market.
Click here to find out which company and download a FREE report that shows you how we made 243.5% returns in this "super" investment. An avid investor himself, Adam shares his personal thoughts and opinions as he journals his investing journey online. The $6.00 strike price option has extrinsic value of 8 cents, the difference between the premium and the exercise value.
The futures position can then be offset by buying a futures contract at the lower price for a gain.
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