Option Terminology
Option Buyer: The buyer (holder) of an option can choose to exercise his right and take a futures position or do nothing, although he nearly always sells the option if it has intrinsic and/or time value. A producer who wants to hedge either production or purchases would typically be an option buyer.
Option Seller: An option seller is also called the writer or grantor. The seller is usually a speculator or progressive producer and is obligated to take the opposite futures position, if the buyer exercises his right. In return for the premium, the seller assumes the risk of taking an adverse futures position. Producers are oftentimes option sellers if there is unsold grain in the bin.
Put Option: A put option gives the buyer (producer) the right to sell (go "short") a futures contract at a predetermined price on or before an expiration date. For example, a November soybean $9.20 put option floors beans at $9.20 futures, less the cost of the premium. This is price insurance against prices falling below that strike price.
Call Option: A call option gives the buyer the right to buy (go "long") a futures contract at a specific price on or before an expiration date. For example, buy a July corn $4.50 call for 10¢ per bushel. These are often called courage calls, so if and when July prices hit $4.50 you have in place the desired re-ownership.
Strike Price: The strike price, also known as the exercise price, is the price at which the option holder (buyer) may buy or sell the underlying futures contract. Exercising the option results in a futures position at the designated strike price. The Chicago Mercantile Exchange sets strike prices at $2.00/cwt. intervals for livestock, 10¢ per bushel on corn and 20¢ per bushel on soybeans. Strike prices are set around the existing futures prices. Additional strike prices are added as the futures market moves higher or lower or closer to expiration.
Underlying Futures Contract: The corresponding futures contract that may be purchased or sold upon the exercise of the option. For example, an option on a June live cattle futures is the right to buy or sell one June live cattle futures contract.
Premium: The market determines the cost of an option. The premium of an option at a specific strike price is ultimately determined by the willingness of buyers to purchase the option and sellers to sell it. Factors that affect this willingness are strike price level relative to the futures price level, time remaining until expiration, and market volatility.
Exercise: Action taken by the buyer of an option who wants to have a futures position. Only the buyer has the right to exercise the option. (The seller has the obligation to take an opposite, possibly adverse, futures position of that of the buyer and for this risk receives the premium.)
Intrinsic Value: The dollar amount of an in-the-money option, which would be realized if the option were to be exercised. Example: Call options are futures – strike price and put options are strike price – futures.
Expiration Date: The last day that an option may be exercised or offset. Exercising a put would mean that you would have a short futures position. Exercising a call would mean that you would have a long futures position.
Commission: The amount of money you pay the brokerage firm to execute your order.
