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Don't Forget, You Can Buy Or Sell An Option Contract, Analyst Says

If you sell both calls and put options it's called a strangle.

In the world of option trading, you can purchase or sell options to initiate a position. An option seller is also known as an option writer. Those who purchase options are buying fixed risk instruments with unlimited potential.

The advantage to purchasing options is that you know what your risk is, and you have the ability to convert your option into a futures contract. You may also exit this position by selling it back to the market. Most options are relatively liquid, especially in the front months.

An arrangement of strike prices (price level you can buy) are available to choose from, making your choice of either the right-to-own futures (call) or right-to-sell futures (put) a relatively easy task. Yet, there is a downside to owning options; typically they will lose most of their time value, if not all of their value, by option expiration.

The math behind options is rather simple. A call option gives the owner the right (not the obligation) to be long futures at a strike price. At expiration date, if futures are at or below that strike price, the call option will lose all of its value. If you think about the arrangement of strike prices available prior to expiration, all call options above the futures settlement price on the last trading day will expire without value.

Because time is also a component of option pricing, time value will erode as expiration approaches. This will leave only intrinsic value at expiration day, if the option is in the money.

Another way to look at owning options is owning a tool that provides unlimited potential and limited risk. Of course, there are some downside parameters, which are that most options lose value. The opposite of buying options is selling/writing options. On the surface, option writing may not sound attractive, as you incur unlimited risk and a fixed profit. However, most options expire without value, thus favoring option sellers.

With his winter/spring rally in corn prices, it is likely that producers sold both old and new crop. One strategy to consider is a short strangle. That is, selling out-of-the-money calls and out-of-the-money puts. Let’s assume you take this position on September options. At option expiration on August 24, if the futures price of September corn is below the sold call strike price and above the sold put strike price, both options will lose all their value, benefitting the seller.

If futures are above the short call strike price, both premiums are still collected, and the short call will be converted into a short futures position at the sold call strike price.

If futures end below the strike price of the sold put, you still collect both premiums and are assigned a long futures at the lower sold put strike price. What you are doing is positioning yourself to collect premium, or collect premium and either be short futures at a higher level or long futures at a lower level than where the futures market is the day you sell/write the strangle.

While this strategy is not for everyone, it should challenge your thinking, and encourage you to understand options and the value of both buying and selling for the right reasons. 

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If you have questions or comments, contact Top Farmer at 1-800-TOP-FARM Ext 129.

Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Past performance is not necessarily indicative of future results.

Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Hypothetical performance results have many inherent limitations. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. No representation is being made that scenario planning, strategy or discipline will guarantee success or profits. The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Reproduction of this information without prior written permission is prohibited. This material has been prepared by a sales or trading employee or agent of Stewart-Peterson and is, or is in the nature of, a solicitation. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Stewart-Peterson. Stewart-Peterson refers to Stewart-Peterson Group Inc. and Stewart-Peterson Inc. Stewart-Peterson Group Inc. is registered with the Commodity Futures Trading Commission (CFTC) as an introducing broker and is a member of National Futures Association. Stewart-Peterson Inc. is a publishing company. A customer may have relationships with both companies. Accordingly this email is sent on behalf of the company or companies providing the services discussed in the email.

 

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