Join        Login             Stock Quote

Which Option to Buy?

 August 08, 2007 11:04 PM


Buying options on futures has the advantage of limiting downside risk. The most you can lose on an option purchase is the cost of the option (including commissions), and that's all. If you think that the price of a commodity, say, corn is going to rise, then buy call options on corn. If, on the other hand, you feel that corn will fall in price, then buy put options on corn. It's that simple...or is it?

For each expiration month, options are listed having several strike prices. For example, assume that it is now November and that we are interested in corn options that expire the following March. Listed below are sample prices for March call options on corn having a strike price that range from 260 cents per bushel to 320 cents per bushel.

March Corn Call Options
Strike Open High Low Closing Range Settle Net Chge
260 28 28 27 1/4 27 1/4 27 1/4 -7/8
270 20 21 19 1/2 19 3/4 to 20 19 7/8 -1/2
280 14 1/2 14 3/4 13 1/2 13 3/4 13 3/4 -1/2
290 9 1/2 10 9 9 1/8 to 9 1/4 9 1/8 -1/2
300 7 7 6 6 1/8 6 1/8 -1/2
310 4 1/2 4 1/2 4 4 to 4 1/8 4 -3/8
320 3 3 2 1/2 2 7/8 2 7/8 -1/8

[Related -Gold Stalls into $1,200 Target with Trade Planning]

Notice that the price of a call option depends upon the strike price. Call options having a high strike price cost less than call options having a lower strike price, all else constant. For example, the 310 call option costs only $200 (calculated as 4 cts/bu x 5,000 bu) plus commission and fees, while the 270 call option costs $993.75 (calculated as 19.875 cts/bu x 5,000 bu) plus commission and fees. When determining which option to buy, consider the price. Buy an option that you can afford. For instance, you may want to only pay between $400 and $700 for an option. Don't be tempted by inexpensive call options having a very high strike price. While they may be cheap, it is also likely that they will expire worthless, since the price of the underlying futures must rise beyond the strike price of the call option by the time the option expires for it to have value upon expiration.

[Related -Has Warren Buffett Found The Best Investment In Oil?]

Try to pick an option that falls within your cost range and that has a strike price fairly close to the price of the underlying futures contract. This option is called an at-the-money option. At-the-money options tend to be the most liquid and actively traded options. For instance, if corn futures settled at 286 cents/bushel, then the 280 and 290 call options are at-the-money. The 290 call option settled at 9 1/8 cents per bushel, giving it a price of $456.25 which falls within the price range. This, then, seems like a good choice.

The above example compared the prices of call options that expired in March. Options that have a longer time until expiration will cost more. For instance, the 290 call option that expires in May may trade at 16 1/8 cents per bushel, or $806.25.

Next Page >>12

Buying Options Understanding Option Prices


Comments Closed

rss feed

Latest Stories

article imageHas Warren Buffett Found The Best Investment In Oil?

Shares of oil stocks plunged again as the price of West Texas Intermediate wiped out nearly half of its read on...

article imageDemand For Safe-Haven Bonds Surged Last Week

The crowd piled into investment-grade bonds last week as economic worries triggered an exodus out of risky read on...

article imageThoughts on MetLife and AIG

In some ways, this is a boring time in insurance investing.  A lot of companies seem cheap on a book and/or read on...

article imageA 2016 Recession Would Be Different

If the US or the Eurozone entered a recession this year, a few macroeconomic variables would look very read on...

Popular Articles

Daily Sector Scan
Partner Center

Related Articles:

The Return Of Crisis
More Articles on: Learning Curve

Fundamental data is provided by Zacks Investment Research, and Commentary, news and Press Releases provided by YellowBrix and Quotemedia.
All information provided "as is" for informational purposes only, not intended for trading purposes or advice. iStockAnalyst.com is not an investment adviser and does not provide, endorse or review any information or data contained herein.
The blog articles are opinions by respective blogger. By using this site you are agreeing to terms and conditions posted on respective bloggers' website.
The postings/comments on the site may or may not be from reliable sources. Neither iStockAnalyst nor any of its independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. You are solely responsible for the investment decisions made by you and the consequences resulting therefrom. By accessing the iStockAnalyst.com site, you agree not to redistribute the information found therein.
The sector scan is based on 15-30 minutes delayed data. The Pattern scan is based on EOD data.