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What do I do now?

Agriculture.com Staff 07/27/2007 @ 8:45am

Options on August futures expire today. Normally I would not care because I seldom have a position in that contract month.

It is different this time. I was short futures early in July when soybean prices took a big jump. I did not want to keep putting in margin money but I also did not want to exit a position with a big loss, because of the probability that prices would come back down. My solution was to exit the short futures position and buy an at-the-money August put.

My fears came to pass and by overnight trade last night, my put was more than 50 cents in-the-money. With expiration imminent, I now have to make a decision on what to do with it. My seasonal system does not go long until July 31, so if I stick strictly with the system, I need to be short two more days. There are at least four possible alternatives.

The first is to simply sell the option today at whatever price the market is trading. On the last trading day, there are usually enough arbitrageurs to get close to fair value. There is commission on this transaction and it leaves me out of the market for the two days I want to be short.

A second possibility is to buy a futures contract and exercise the option. That will give me exactly what the option is worth at the end of the day, but it is subject to the price I pay for the futures contract. There is commission on both sides of this trade. The advantage is that the futures market is more liquid than the market for options that far in-the-money, so the odds of a good fill are better. I would still be out of the market for two days.

A third alternative is to exercise the option and stay short the August futures until Tuesday. There is only one commission on this approach. The down side is that I have a position in futures during delivery, which begins Monday. Being short for a few days during delivery is not usually a problem, because sellers set the delivery day and I would not be holding the position into the delivery month.

A fourth choice is to buy August futures, sell November futures and exercise the option. This strategy comes closest to achieving what I want from the trade. It gets the value out of the option and leaves me short November futures until I exit the position next Tuesday. The down side is that it costs three commissions.

I have not decided yet which approach to take. If I do nothing, the broker will liquidate for me because he will not let an in-the-money option expire worthless. I am not sure which approach he will use. I want to be in control so I know what position I will have when the market opens Monday morning.

One thing I like about options is that there is a lot of flexibility in what you can do. In this case, having flexibility creates a decision that I must make to get the maximum profit. At least it is better than having the option expire worthless, which is a more common outcome!

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