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OPTIONS TRADING STRATEGIES
BUYING FCOJ CALL OPTIONS
Let's say that you have just watched frozen concentrated orange juice (FCOJ) rally some 20 cents in early October
and this has convinced you that FCOJ will be heading higher. You expected some consolidation after such a rapid rise and this
has occurred over the subsequent weeks. On November 2, FCOJ dropped 4.50 cents and this presents the buying opportunity
for which you have been waiting. (See chart at right.) You expect prices to rally over the next few months and
are considering buying a FCOJ call option.
The first step of the
purchase decision
is to determine the maturity of the call option: it must be long enough to capture the anticipated price rally.
Since the rally could span the next several months, you conclude that the
March 2010 FCOJ call options that
expire in
mid February
will be sufficient. The second step is determining the strike price.
March FCOJ call options are available across a wide range of strike prices, each having a different cost.
(See table at right.)
Reading FCOJ Option Prices
FCOJ options are priced
in cents per pound up to two decimals. One FCOJ option can be exercised into one
FCOJ futures contract and since each contract is based on 15,000 pounds of orange juice solids, the option price must be
multiplied by 150 to get a corresponding dollar value and every one cent change in the price of the option or the underlying
futures for that matter is worth $150 per contract.
For example, the March FCOJ call option struck at 11500 (or 115.00 cents per pound) settled at 1170 meaning 11.70 cents per pound.
The dollar value of this option is 11.70 x 150 = $1,755. This call option is at-the-money
since the March futures contract settled the day at 114.85 cents per pound. Notice that the futures closed
lower over the day by 4.50 cents per pound taking all call option prices lower as well but that the option prices moved by less
than this amount. In fact, this at-the-money call option fell by just 2.65 cents per pound.
As is evident in the table, as the strike price of a call option is raised,
its price declines
as does its sensitivity
to movements in the price of the underlying futures.
Choosing the Strike Price
This requires balancing risk with potential return. The former is simply the cost or purchase price of the option
along with brokerage commission and other trading fees. For example, if you want to risk at most no more than $1,200
on a March FCOJ call option, then only those options having a strike price of 13000 (or 130.00 cents per pound) or higher would be acceptable.
The potential return is based upon your expectation of how far FCOJ prices will rally. A useful reference is the
break-even price.
The break-even price of a call option
is calculated by adding the option cost and paid trading fees to the strike price.
Consider, for example, the March FCOJ call option struck at 12500 (or 125.00 cents per pound). If it is
purchased at the settlement price shown, then the break-even
price of the March futures at option expiration is calculated as:
125.00 + 8.45 + fee value = 133.45 + fee value.
At option expiration, March FCOJ futures must be above this break-even price in order to
profit on the option trade.
So, you will only consider call options that have a break-even price below the price to which you expect
FCOJ will rally. Let's say, for example, that you believe March FCOJ can reach 150 cents per pound by option expiration.
Based on this, you would only consider buying call options having a strike price of 14500 (or 145.00 cents per pound) or lower
since otherwise the break-even price is too high.
What remains is the range of acceptable options. In this case, for an investment of at most $1,200 and with an expectation that March
FCOJ will rally to 150.00 cents per pound by option expiration, the call options having a strike price within the range of 13000 to 14500
would be acceptable to purchase.
After the purchase, you will need to manage the option position.
What if there are no remaining options that are acceptable after considering your desired risk and price expectation? Then you
can consider buying a more expensive call option and manage the risk, or
you can consider buying a bull call spread.
Bull Call Spread
When buying a bull call spread, both strike prices should be below the price to which
you anticipate the futures will rise by the time the options expire, in this case, 150 cents per pound. Based on this, there are several spreads
that can be purchased. For example, the 13000/14000 bull call spread has a value of 7.15 - 5.00 = 2.15 = $322.50 plus commission and fees.
If March FCOJ futures is above 140 cents per pound at the time of option expiration, then this spread will close
at its maximum value of $1,500 (calculated as 10 cents x $150 per cent). If FCOJ is below 130 cents per pound, then this spread will expire worthless.
Stepping down the strike prices will increase marginally the cost of the spread, but the chance of the maximum value
being earned is greater since FCOJ need not rise so far. For example, the 12000/13000 bull call spread has a value
of 9.95 - 7.15 = 2.80 = $420 plus commission and fees. March FCOJ need only be above 130 cents per pound at the time of option expiration
to earn the $1,500 maximum value of the spread. If FCOJ is below 120 cents per pound, then this spread will expire worthless.
As you can see, spreads can be constructed at relatively little expense. You can risk more on a spread in return for greater
potential payout by increasing the gap between the two strike prices. For example, the 12000/14000
bull call spread has a value of 9.95 - 5.00 = 4.95 = $742.50 plus commission and fees but the maximum value is $3,000
and will be earned if March FCOJ futures is above 140 cents per pound at the time of option expiration.
Because the market for option spreads is generally less active than the market for individual options,
you will likely have to pay a slightly higher price in order to effect the purchase. After the purchase,
you will need to manage the option spread position.
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March 2010 FCOJ Futures
Settle as of Nov 2, 2009: 114.85 Change: -4.50
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March 2010 FCOJ Call Option Prices
Prices as of Nov 2, 2009. Source: The ICE
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Test your skill at trading FCOJ options in a futures and options paper trading account.
Staffed by salaried, not commission personnel, you'll speak directly with a futures professional who will
provide any educational support that you may need. Click image above for more information.
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