Posted by: usset001 | April 16, 2009

commodity options exam (continued)

shh - still testing!

shh - still testing!

I offered two exam questions in yesterdays post. People want answers!

The first question asked: Assume you pay a premium of 4 cents per pound for a live cattle call with a strike price of 75 cents. The underlying futures price is 73.5 cents. What is the time value of this option?

The answer is “c” or 4 cents per pound. An option premium is made up of two components, intrinsic value and time value. Intrinsic value refers to how much the option is “in-the-money.” In this particular case, a 75 cent live cattle call is out-of-the-money when the futures price of 73.5 cents is less than the strike price. Intrinsic value is never negative – it is either positive or zero. Since the intrinsic value is zero the entire premium, or 4 cents per pound, can be attributed to time value.

To simultaneously buy July wheat and sell July corn futures is an example of an (a) intercommodity spread. Spreading (or, as some prefer to call it, arbitrage) is a fascinating aspect of futures trading and risk management. I need to spend more time on the topic.

Now for today’s questions – good luck and no cheating!

The option premium and option strike price are (respectively)…

  • a. set by the exchange and determined at expiration
  • b. set at expiration and determined when exercised
  • c. negotiated by open outcry and determined by the exchange

When a put option is exercised, the buyer of a put…

  • a. is long a put
  • b. is short a call
  • c. is long the underlying futures contract
  • d. is short the underlying futures contract
  • e. pays the premium

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