have higher deltas than out-of-the money (OTM) options, while at- NATURAL EDGE STRATEGy the-money (ATM) options will have a delta of approximately 50, which FOR DECEMbER 2008 CORN: $5.85 FOR NOvEMbER 2009 SOybEANS: $13.01 implies that prices have a 50-50 chance of going up or down. It can also be looked at as a probability factor with a 0 delta representing no chance of finishing in the money and a 100 delta representing a 100% chance it will end in the money.
bUy: $5.00 put (85¢ otm) = 9¾¢ SELL: $7.00 call ($1.15 otm) = 12¼¢
bUy: $10.00 put ($3.01 otm) = 59¢
(For a 2½¢ premium collection: 12¼ - 9¾ = 2½¢)
SELL: $20.00 call ($6.99 otm) = 62¢ (For a 3¢ premium collection: 62 - 59 = 3¢)
FLOOR: $5.02½
FLOOR: $4.02 1/2
(put + premium collected)
(put + premium collected)
CEILING: $7.02½
CEILING: $20.02½
The buyer of a call will have a positive delta; the buyer of a put will have a negative delta. Deltas are not static and shift as the fu- Above are examples of a natural edge option technique from 8/29/08 in which the puts tures (underlying) market moves. are purchased and calls are sold. Natural edge is calculated by taking the distance the
(call price + premium collected)
(call price + premium collected)
NATURAL EDGE: 32½¢
NATURAL EDGE: 4.00½¢
Because deltas are always changing, short call strike is out of the money (otm) minus the distance otm of the long put strike, any hedging strategies need to be then either adding the premium collected (as in the above example) or subtracting the adjusted accordingly on a relatively premium paid. Using the corn example, the $7.00 calls are $1.15 otm, the $5.00 puts constant basis. are 85¢ otm, and the premium collected is 2½. So, $1.15 - 85¢ = 30¢ + 2½¢ collected =
32½¢ natural edge.
clearing up options mayhem
Despite what sometimes seems like utter chaos and mayhem, op- natural edge in grain markets The biggest risk in grain markets tions markets are, in fact, orderly In theory, all options in the same (or in most commodity markets) is and uniform. There are some basic month should have the same volatil- that prices rise so far that the end and easy-to-understand concepts ity. But in actual option markets, this user can’t afford to buy the com-that are essential to understanding is rarely the case. modity they need to produce their the marketplace. end product. As a result, grain mar-
The first and most important option concept is called put/call parity.
This is simply the relationship between a futures contract and the same strike, put and call.
The formula is:
Call Price - Put Price + Strike Price = Futures Price
Therefore, if you know any two of the inputs, the third can be calculated. This triangular relationship is the cornerstone of understanding how options work and is true across the whole range of OTM and ITM strikes.
Todd Swenson, a member of the soybean options pit committee, helps determine the lead contract month to be traded. Usually, the lead contract has the heaviest trade volume.
References:
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