Question

(a) Briefly outline two differences between futures and options contracts.

(b) In August, a wheat farmer decided to hedge her entire anticipated 1,000 tonne wheat harvest with January wheat futures that were trading at a price of $290 per tonne.

In January, the farmer harvested 1,000 tonne of wheat and sold this wheat at auction for $270 per tonne. She then closed out her January wheat futures contracts for $272 per tonne.

From this information and using a standard wheat futures contract size of 20 tonne per contract, calculate the overall value of the harvested crop including the profit or loss from futures trading.

(c) On 11 April 2018, Commonwealth Bank of Australia (CBA) shares were trading at $74.00 while the October 2018 CBA Call and Put options with exercise prices of $80.00 were trading at $0.80 and $5.00, respectively.

Given this information and the fact that the standard option contract size is 100 shares per contract, outline an option arbitrage trading strategy, demonstrate that the strategy is profitable and briefly discuss the effect your arbitrage trading has on your ability to continue to make arbitrage profits.

Answer 1

Ans:

Both Options and features are called derivatives because they derive their value from an underlying market.

A Futures contracts creates an obligation to buy or sell physical goods at a future date.

And an option contracts create a right but not an obligation to do the same under options contract you can buy and sell right to buy or the call option and right to sell or the put option.

Depending upon the market movements this makes options are more complex and advanced derivative to trade in to participate in options one has to pay a premium for the right to the end result.

In case of futures contracts you pay or receive a small down payments towards the end result.

The level of risk in futures is high whereas options carry limited risk the most you can lose when you buy call or put options is your initial outlay.

The execution of future contracts can only be done on the pre decided date.

In options contracts requires the performance to be done at any time prior to the date of expiry.

These are some fundamental differences that affect the level of risk involved.