Back To School Quiz #1

Explanation
Basis is an important concept in grain marketing. It is the difference between cash and futures prices. Mathematically speaking; basis = cash price – futures price (and not the other way around!). Basis in most parts of the cornbelt, particularly the northern half, is usually a negative number, i.e., cash prices are less than futures prices. Occasionally I meet a confused producer who tells me that he had a bad day because his basis “increased” from 50 to 60 cents. I can’t help but point out that his basis actually decreased, from -50 cents to -60 cents (50 cents under to 60 cents under). This is the type of small, irritating correction that rarely earns me a thank you.

Explanation
The buyer of a put option has bought the right to sell futures. If the buyer exercises the right to sell, who will take the other side (the long side) of the futures contract? That would be the seller of a put option.

By the way, the buyer of the future is not necessarily the same individual who originally sold the exercised put. The trader obligated to buy the futures contract will be the oldest seller of the particular put in question. The process of assigning the other side of an exercised option is similar to the delivery process in grains. In delivery, however, it is the seller of futures who has the right to choose to deliver grain, and the “lucky” buyer is determined by the oldest long in the market.

Explanation
While most futures trades and prices are now executed electronically, it is still accurate to say that options premiums are negotiated the old-fashioned way; open outcry in a trading pit. Strike prices, also known as exercise prices, are determined by the exchanges. Strike prices for soybean options are established in 20 cent increments (e.g., 900, 920, 940 calls). Corn option strike prices are in 10 cent increments.

Explanation
According to the June WASDE report, food, seed and industrial demand for corn in 2009/2010 is projected to reach 5.4 billion bushels, larger than 5.1 billion bushels of feed demand. Corn exports are projected to be a little less than 2 billion bushels. High industrial demand for corn is driven by growth in ethanol production; 4.1 billion bushels in 2009/10 and more than 3 times higher than just 5 years ago. By the way, this will mark the first time that feed demand is not be the largest part of total corn demand.

Explanation
Intrinsic value and time value are the two primary components of an option premium. Intrinsic value refers to how much an option is “in-the-money.” A call option is in the money if the strike price is less than the underlying futures prices (e.g., a $9 November soybean call would be 50 cents in-the-money if November futures are trading at $9.50 – there is 50 cents of intrinsic value). A put option is in the money if the strike price is greater than the underlying futures prices. Intrinsic value can only be a positive number or 0. There is no negative intrinsic value.

Explanation
An option premium is made up of two components; intrinsic value (if any) and time value. In this case, when the futures price ($9.75) is trading less than the strike price of the call ($10), there is no intrinsic value – the option is trading 25 cents “out-of-the-money.” If there is no intrinsic value, then the entire premium of 90 cents per bushel can be viewed as time value.