Thus, a hedger or speculator has the option of purchasing an option at any of these three levels. Typically, options in the money will have the highest premium, followed by options at the money, and options out of the money will be the cheapest. The option premium is the value the hedger pays for the right to later take a futures position. Any of three scenarios can arise between the cash and option value. Even though a loss may be shown from taking a position in the options market, the final price must be compared to purchasing the grain in advance and paying storage costs.
Basis is held constant for the examples below.
A. Cash Price and Options Value both Increase Table 1 outlines the example of a long hedge using a call option in which the cash price and futures price increase. An increase in futures price is assumed to be positively related to a change in the option value. Thus, the option value increases. Suppose today Heidi Hog Farmer knows that she will be purchasing a pen of weaner pigs a few months from now. However, she is concerned that the price may increase prior to purchasing the hogs.