Dairy Futures and Options Tutorial

Comparison of the Use of a Call Option to Establish Cost Ceiling Versus Use of a Long Hedge

Below we show you how you can use a CALL option to establish a cost ceiling for your milk input. First, enter either hypothetical or actual market closin g data for a particular call option.

Current Date:

What Options do you want to investigate

Please input the relevant price futures and options information:

Current Futures January Class III Settle Price
January Class III Put Strike Price
January Class III Put Strike Price
January Class III Put Strike Price

The following shows the expected output price you would receive if you enter into a long hedge using the above futures settle price, your basis and commissions:

Result if you had hedged
Futures Settle Price + Assumed Basis + Futures Commission = Expected Hedged Input Cost
0.00 0.00

With the above strike prices, the following maximum purchase costs are established if you purchase a call option. Remember you are assuming the above basis relationship.

Establishment of Maximum Input Cost
Strike Price + Call Premium + Options Contract Commission + Futures Contract Commission + Basis Maximum Input Cost established through Call
0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00 0.00

Assume a number of days, weeks or months pass. It is expected that the final settle price for January Class III futures contract will have changed since . Below you can enter the final futures contract settle price. Assuming your basis does not change, you also know the actual cash market price at contract settle. Let us conduct some what-if scenarios. First, what would have been the impact if you had hedged your output using the futures contract settle price noted above. As shown in the hedging table, you would have locked in an input price of 0.00 regardless of the final settle price. What would have been the impact if you had purchased one of the the above CALL options? To provide a comparison of the short hedge versus use of options to establish a minimum price select either Exercise or Let Expire in the following example after you input a final cash settle price for the underlying futures contract.

After you decide whether you want to exercise your option, the implications of this decision on your net selling price is displayed in the next to last column of the following table. You may want to try one action, examine the impacts and then try the other action. You then may want to intially input a final cash settle price that is less than 0.00, try both decisions with respect exercising your option, and then redo the example by changing the final cash settle price so that it is significantly greater than 0.00.

Expected Hedge Input Cost: 0.00
Final Cash Settle Price:
What do you want to do with your option?
Exercise Let Expire

Here are the implications if you had purchased put options:

Net Input Cost Under the Call Option
Options Strike Price Final Settle Price Basis (+) Actual Cash (=) Option Gains (-) Net Input Cost under Options Preferred Strategy
0.00 0.00 0.00 0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00 0.00 0.00 0.00
0.00 0.00 0.00 0.00 0.00 0.00 0.00