Buying Oats Call Options to Profit from a Rise in Oats Prices

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Contents

Buying Oats Call Options to Profit from a Rise in Oats Prices

If you are bullish on oats, you can profit from a rise in oats price by buying (going long) oats call options.

Example: Long Oats Call Option

You observed that the near-month CBOT Oats futures contract is trading at the price of USD 2.0900 per bushel. A CBOT Oats call option with the same expiration month and a nearby strike price of USD 2.1000 is being priced at USD 0.1400/bu. Since each underlying CBOT Oats futures contract represents 5000 bushels of oats, the premium you need to pay to own the call option is USD 700.00.

Assuming that by option expiration day, the price of the underlying oats futures has risen by 15% and is now trading at USD 2.4040 per bushel. At this price, your call option is now in the money.

Gain from Call Option Exercise

By exercising your call option now, you get to assume a long position in the underlying oats futures at the strike price of USD 2.1000. This means that you get to buy the underlying oats at only USD 2.1000/bu on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying oats futures at the market price of USD 2.4035 per bushel, resulting in a gain of USD 0.3040/bu. Since each CBOT Oats call option covers 5000 bushels of oats, gain from the long call position is USD 1,520. Deducting the initial premium of USD 700.00 you paid to buy the call option, your net profit from the long call strategy will come to USD 820.00.

Long Oats Call Option Strategy
Gain from Option Exercise = (Market Price of Underlying Futures – Option Strike Price) x Contract Size
= (USD 2.4040/bu – USD 2.1000/bu) x 5000 bu
= USD 1,520
Investment = Initial Premium Paid
= USD 700.00
Net Profit = Gain from Option Exercise – Investment
= USD 1,520 – USD 700.00
= USD 820.00
Return on Investment = 117%

Sell-to-Close Call Option

In practice, there is often no need to exercise the call option to realise the profit. You can close out the position by selling the call option in the options market via a sell-to-close transaction. Proceeds from the option sale will also include any remaining time value if there is still some time left before the option expires.

In the example above, since the sale is performed on option expiration day, there is virtually no time value left. The amount you will receive from the oats option sale will be equal to it’s intrinsic value.

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Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

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Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

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Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Hedging Against Rising Oats Prices using Oats Futures

Businesses that need to buy significant quantities of oats can hedge against rising oats price by taking up a position in the oats futures market.

These companies can employ what is known as a long hedge to secure a purchase price for a supply of oats that they will require sometime in the future.

To implement the long hedge, enough oats futures are to be purchased to cover the quantity of oats required by the business operator.

Oats Futures Long Hedge Example

An oats mill will need to procure 500,000 bushels of oats in 3 months’ time. The prevailing spot price for oats is USD 2.0900/bu while the price of oats futures for delivery in 3 months’ time is USD 2.1000/bu. To hedge against a rise in oats price, the oats mill decided to lock in a future purchase price of USD 2.1000/bu by taking a long position in an appropriate number of CBOT Oats futures contracts. With each CBOT Oats futures contract covering 5000 bushels of oats, the oats mill will be required to go long 100 futures contracts to implement the hedge.

The effect of putting in place the hedge should guarantee that the oats mill will be able to purchase the 500,000 bushels of oats at USD 2.1000/bu for a total amount of USD 1,050,000. Let’s see how this is achieved by looking at scenarios in which the price of oats makes a significant move either upwards or downwards by delivery date.

Scenario #1: Oats Spot Price Rose by 10% to USD 2.2990/bu on Delivery Date

With the increase in oats price to USD 2.2990/bu, the oats mill will now have to pay USD 1,149,500 for the 500,000 bushels of oats. However, the increased purchase price will be offset by the gains in the futures market.

By delivery date, the oats futures price will have converged with the oats spot price and will be equal to USD 2.2990/bu. As the long futures position was entered at a lower price of USD 2.1000/bu, it will have gained USD 2.2990 – USD 2.1000 = USD 0.1990 per bushel. With 100 contracts covering a total of 500,000 bushels of oats, the total gain from the long futures position is USD 99,500.

In the end, the higher purchase price is offset by the gain in the oats futures market, resulting in a net payment amount of USD 1,149,500 – USD 99,500 = USD 1,050,000. This amount is equivalent to the amount payable when buying the 500,000 bushels of oats at USD 2.1000/bu.

Scenario #2: Oats Spot Price Fell by 10% to USD 1.8810/bu on Delivery Date

With the spot price having fallen to USD 1.8810/bu, the oats mill will only need to pay USD 940,500 for the oats. However, the loss in the futures market will offset any savings made.

Again, by delivery date, the oats futures price will have converged with the oats spot price and will be equal to USD 1.8810/bu. As the long futures position was entered at USD 2.1000/bu, it will have lost USD 2.1000 – USD 1.8810 = USD 0.2190 per bushel. With 100 contracts covering a total of 500,000 bushels, the total loss from the long futures position is USD 109,500

Ultimately, the savings realised from the reduced purchase price for the commodity will be offset by the loss in the oats futures market and the net amount payable will be USD 940,500 + USD 109,500 = USD 1,050,000. Once again, this amount is equivalent to buying 500,000 bushels of oats at USD 2.1000/bu.

Risk/Reward Tradeoff

As you can see from the above examples, the downside of the long hedge is that the oats buyer would have been better off without the hedge if the price of the commodity fell.

An alternative way of hedging against rising oats prices while still be able to benefit from a fall in oats price is to buy oats call options.

Learn More About Oats Futures & Options Trading

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Continue Reading.

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Call Options 101 | Help Capture Rallies on Grain Already Contracted

Like corn and soybean futures and put options, calls are offered through the CBOT. You have to search a little more to find options prices, but they’re there. Put and call option prices premiums are listed, based on various futures quotes. According to CME, buying a call option “gives you the right, but not the obligation, to buy a product on the underlying futures contract at a specific price. The underlying futures contract is the one with the same delivery month as the option.”

The call market is commonly used for price protection by processors, exporters and livestock-feeding operations to insure a maximum purchasing price for grain or soybean meal. For farmers, calls are often tools to cover increases in the market.

Bob Wisner, long-time grain marketing guru for Iowa State University and professor emeritus, says calls can enable growers to sell grain at harvest – but retain the opportunity to benefit from rising prices.

“Producers can offset harvest sales by buying call options,” Wisner says. “If futures prices rise significantly above the initial strike price, the options contracts should increase in value. If prices decline, the producer would lose only the initial premium payment plus a small brokerage charge.”

An at-the-money call or put option strike price is equal to the particular month’s futures price. Typically, as the call option strike price increases, the cost for buying the option decreases, just the opposite of a put option.

For example, in mid-January, an at-the-money December 2020 $5.90 corn call option cost about 58¢/bu. But an out-of-the-money $7 December call cost about 25¢/bu. A $7.50 call cost about 16¢. If the futures price and thus the call strike price increased from the $5.90 level, the value of the option would likely increase.

If you have corn cash contracted at the $5.90 price, that is your floor price, less any basis. If the market takes off, you can still be in the market for higher prices with a call option in place.

Wisner says few expected 2020 to see a second straight year of shorter corn crops due to dry weather. But it happened. And it’s showing up in shorter ending stocks. A reduction in 2020 expected yields could also create a situation in which prices increase strongly in the spring and summer or even later.

“Three consecutive years of a shorter crop is unlikely, but the forecast is for dry weather in the northwest Corn Belt,” Wisner says. “The corn market could explode on the upside with another year of serious U.S. or South American weather problems. A call option would help growers take advantage of that upside market.”

He says the $7.50 put, bought at about 16¢/bu., could be worth 50¢ if the market would rise to $8 or higher. “If it reaches $8.50 near the contract delivery month, that call option could be worth $1/bu.,” he says.

Wisner says growers should consider using call options that are in months that normally expire following potential weather problems. “A September option would expire about Aug. 20,” he says. “A December would expire about Nov. 20.” He adds that growers most likely would sell back the option to take the added premium before its expiration.

He encourages growers to evaluate their risk coverage needs before using call or put options or other marketing tools. “The strike price a producer uses depends on his or her risk situation,” he concludes. “Certainly, for someone looking at the possibility of using calls to protect against a weather market, that $7.50 would be a possibility at its low cost (16¢ in mid-January).”

Remember that futures and options prices can change by the minute, so keep an eye on the quote board as often as possible if a strong bull market should develop.

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