Why are put options so expensive?

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Part six in a series: Understand how to add value to your selling price with options.

On April 21, 2022, September 2022 CBOT wheat futures settled 20 cents lower at $10.75¼.  

The $10 September wheat put premium should have increased 6½ cents (delta times 20 cents). However, it increased about half that much. See the price chart below.

The $9 September put premium should have increased by a little more than 3½ cents (delta times 20 cents), but it lost a quarter cent! 

Clearly, the option traders are bullish wheat and many traders realized that the big spec funds were trying to muscle the May futures lower by the close to make as many call options as possible expire worthless.

Why do big spec traders want to make as many call options as possible expire worthless? Most of the options bought are by small traders and they buy them from mostly the big spec funds, who are comfortable taking the margin call risk of writing an option. Writing an option is selling an option to establish a market position. Writing an option is selling an option that has not been previously purchased. Options writers are short the option. They want the value of the option to decline so they can buy it back at a lower price than they wrote (sold) it for or, better yet, the option expires worthless so the writer of the option does not need to buy it back at any price.

How does an option expire worthless? We had a client who wrote a CBOT May $20 call for 38 cents a bushel the day the war started (February 24). In exchange for 38 cents, he was giving the option buyer the right, without the obligation, to make our client sell him May wheat futures at $20 any day until May options expired, which was on April 22.  May wheat settled at $10.65½ on expiration day. Do you think the guy that paid 38 cents for right to buy May wheat futures at $20 wanted to buy May wheat at $20, or would he rather buy it at $10.65½? Yep. So the May $20 call expired worthless and the writer (our client) kept all of the 38 cents he received for the $20 call option on February 24.      

Usually, there are twice as many calls on the books (open interest) as puts. People who buy options just cannot get comfortable buying something (a put) and wanting the futures price to go down. Therefore, non-professional traders buy twice as many call options as they do put options. Professional traders seldom buy call options because they know they are a poor investment.

The big spec funds want to push the futures price down as far as possible the few days before the options expire. Ideally, on option expiration day, they want the settlement futures price to be dead on a strike price so that both the calls and the puts at that strike price expire worthless.

Pay attention to this:

All option buyers have limited financial risk and unlimited financial gain opportunity.

All option writers (sell before they buy) have limited profit potential and unlimited financial risk.

And that, ladies and gentlemen, is why the options are so expensive. We began applying writing options as part of our market plan for our clients who can grasp the concept of writing options. For example, a corn farmer has to sell that corn. In most years, $7 at harvest is a good price for corn. We have a client who wrote 40,000 bushels of $7.00 December 2022 corn calls and received 58 cents per bushel through his grain merchandiser.

Let this soak in: somebody paid a farmer 58 cents per bushel in April 2022 for the right to make that farmer sell him 40,000 bushels of corn of 2022 crop corn at $7.00 HTA.

No matter what the market does, the farmer keeps the 58 cents if he hangs on to the position until expiration day, November 25. The farmer may or may not have to sell his corn at $7.00 HTA. Since the farmer sold and delivered 40,000 bushels of old crop corn, his merchandiser wrote the $7 December calls and added 58 cents to cash price of the old crop corn delivered in March. You could have done the same thing. If you have old crop corn, you can still have value added to your selling price by writing a December call option. The $7.00 December calls today (May 26, 2022) are at 75 cents; the $8 calls are at 41 cents a bushel.     

How many of you are ready to learn more about options?

We had recommended clients buy either the $9 September CBOT wheat put for 26 cents or the $10 put for 59 cents to enhance their HTA price. Below is the chart of CBOT wheat put option settlements for April 21, 2022 with September settled at $10.75¼: 

20 April 2022 Sept Wheat Put $

This is part six in a series. To learn more, read:

Part one: Put options add value to your cash grain sales

Part two: Hedge your crops with no margin calls

Part three: Enhance profit opportunities with put options

Part four: Put options and no margin calls

Part five: When does a put option have no potential value?

Part seven: Use puts to manage grain marketing risk

Wright is an Ohio-based grain marketing consultant. Contact him at (937) 605-1061 or rjw1249@wrightonthemarket.com. Read more insights at www.wrightonthemarket.com.

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. 

 

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