From the September 01, 2011 issue of Futures Magazine • Subscribe!

Trading option break-even prices

Good as gold

A recent and ongoing example of the potential in break-even prices is shown in "Gold & silver: Always good options" (May 2011). On March 1, 2011, December gold futures at $1,435.80 had break-even prices of $1,639.00 and $1,253.00. December silver, at $34.57, had break-even prices of $43.47 and $27.31. The break-even price spread was almost twice as large for silver because of its greater volatility.

By May 2, 2011, December gold had increased to approximately $1,560 and from that point had dropped back to $1,518 on June 13, 2011. On the other hand, December silver exceeded its upper break-even price by hitting $47.18 on April 25 and $47.56 on April 28 before falling to $34.81 on May 12.

One advantage to the purchase of calls and puts at upper and lower break-even prices is that the result of the worst possible scenario (when none of the breakeven prices result in profitable trades and none is used to reduce cost) is known at the time of the original trade.

A sample of 12 futures contracts on June 10, 2011 is shown on "Puts and calls" (below). Although the contracts are all September expirations, the numbers of days remaining vary from 56 to 111. Time remaining and expected price volatility are factors that determine the height of option price curves, with higher curves indicating the market’s expectation of greater changes in the underlying futures or equity price. Direct comparisons can be made between options having approximately equal times to expiration.

It is logical to think that puts and calls on September lumber futures, with the call price curve high at 8.72% of the strike price and 82 days remaining, should be a better speculation than options on soybean oil, with curve height at 3.87% and 77 days to expiration. The dollar index and euro look rather doubtful — even with greater time remaining — because of the market’s low volatility estimates for these currency futures.

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