Options offer the right but not the obligation to buy or sell the underlying futures contract at a certain price (strike). There are two types of options: Calls and Puts. Calls are purchased with the hope the prices will rise, while puts are purchased when the buyer expects prices to fall.
Options can also be sold, the strategy behind selling options is the hope they will lose value or expire worthless and the premium they were sold for can be collected.
Long – Buyer of the options contract
Short – Seller or (writer) of the options contract
Strike price – The futures price by which the put or call option is based. A $5.00 corn call for example means that the buyer of the call has the right or option (but not the obligation) to buy $5.00 futures as long as the option contract lasts.
Premium – Total price or cost of the option contract. Premium is paid to option seller.
Exercise – When an option is exercised the owner buys or sells the underlying futures at the strike price of the option contract.
In-the-Money – Refers to the correlation between the strike price and the current futures price. For calls, it means the strike price is below the current futures price. For puts it means the strike price is above the current futures price. If the buyer owns a $4.00 call and the current futures price is at $4.50, the call is “In-the-Money”.
At-the-Money – When the futures price is equal to the strike price. If the seller is short a $4.00 call and the current futures price is $4.00, the option is considered “At-the-Money”.
Out-of-the-Money – This is the opposite of in-the-money. For calls, it means the strike price is above the current futures price. For puts, it means the strike price is below the current futures price. If a put has a strike price of 4.00 and the futures is trading at $4.50, the put option is out-of-the-money.
Delta – The amount an option will move based on a price change in the underlying commodity. If the delta for an option is 0.20 and the futures price moves $1 the option should move approximately 20 cents. The further an option strike is “Out-of- the-Money” the lower the delta. As an option’s strike price moves closer to the current price and “In-the-Money” the higher the delta becomes. An option’s delta can exceed 1 except for in periods of extreme volatility.