November 24, 2021
With rare exception, when trading options on futures and stocks, people say they bought an option or they sold an option. Pretty logical, but there is a lot more to it than that. Here is why:
Let’s say I sold my cash corn, but I want to maintain a long position in the corn market.
I can buy futures or I can buy call options. If corn futures go up, the call will increase in value. If futures go down and stay down, the worst that can happen to me is I lose what a paid for the call option.
The buyer of an option has limited risk and unlimited profit potential. That is why they are expensive.
At Thanksgiving, my family is talking markets. I tell my siblings I bought a corn call option.
My sister said, “Well, how about that! We finally agree on which way a market is going. I bought a corn call also!”
A month later, corn futures are up 66 cents. At the Christmas dinner, I tell my sister, “Our corn calls really made us some good money this past month!”
She looks at me with a bewildered look on her face and asks, “What are you talking about? I don’t have any corn calls!”
“Sis, you sat right there at Thanksgiving and told all of us you bought a corn call after I said I had bought a call.”
She put on her thinking cap and after I few seconds, she said, “Yea! I did I did buy a corn call, but I liquidated a short call position.”
She had bought a call to get out of the market. I had bought a call to get in the market.
Here’s what happened
Months before Thanksgiving, Sis had established a market positon by writing a call (sell before buying). Thus, when she bought the call before a few days before Thanksgiving, she was getting out of the market, whereas I was getting in the market. Thus, when corn futures rallied 66 cents, she was out of the market and had no option to benefit from the rally.
One can buy an option to open a position and be long the market, or one can buy an option to liquidate a previously established position. Just like with futures, for every buyer, there has to be a seller. And just like futures, one can buy an option first or sell an option first. If the option is sold first, it is not selling an option, it is writing an option.
One can buy an option to get in the market or get out of the market.
One will sell an option to get out of the market.
One will write an option to get in the market.
The seller of an option is always getting out of the market. The writer of an option is always getting in the market.
For all you folks who had delivery contracts that somehow doubled the bushels you had to deliver, that was because your merchandiser wrote call options on your delivery contract. No doubt he told you, but you may not have understood the potential consequences.
No one associated with Wright on the Market is a cash grain broker nor a futures market broker. All information presented is researched and believed to be true and correct, but nothing is 100% in this business.
The opinions of the author are not necessarily those of Farm Futures or Farm Progress.
About the Author(s)
Founder, Wright on the Market
Grain marketing consultant Roger Wright has conducted hundreds of seminars and shared his expertise on weekly farm radio programs as part of his goal to teach marketing concepts to agricultural producers. He was raised on a dairy/hog farm in West Central Ohio and spent four years in the Marine Corps after achieving a Bachelor of Science degree in ag education. He previously taught college-level farm management courses and served as a branch manager for Heinold Commodities and Securities.
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