Swaps, Spreads and Safety Nets

The other new kid

On June 1 the CBOT/CME launched trading in put and call options on spreads in grains and the soy complex (excluding oats and rice). Spread options let grain merchandisers set a floor early on carrying charges for example, rather than locking in a final spread. Spread options will trade by open outcry in the pits and electronically on Globex.

• Listings: nearest 3 spreads, plus an old/new crop spread (e.g., July/Sept, Sept/Dec, & Dec/March corn + July9/Dec9)
• Exercise will be European style (only at expiration)
• Spread option position(s) can be liquidated prior to expiration by either longs or shorts.
• Strike price intervals and daily price limits (expandable after a limit session)

• Strike prices reflect the value of the front month price minus the deferred month price:
  
  • Carry-spread strikes will be a negative value; e.g., July/Sept corn at a 9¢ carry would show as a -9 SP )
  • Inverse strikes will be a positive value
• Exercise/assignment will create futures contract(s) equal to the settlement price of the front month of the spread minus the option Strike Price (differential) of the spread
• Position created at exercise for the option buyer (long):
  
  • Calls: buyer receives long nearby futures + short the deferred month
  • Puts: buyer receives short nearby futures + long the deferred month
• Position assigned to the option writer (short):
  
  • Calls: seller receives short nearby futures + long the deferred month
  • Puts: seller receives long nearby futures + short the deferred month

Here are two basic spread strategies and the option position you would use to protect the strategy include:

It's easy to take for granted the value of our futures exchanges. But their financial safeguards, transparency and liquidity allow grain firms to efficiently manage risk even in turbulent markets. We welcome the new kids on the block: swaps and spread options.