Market Matters Blog
Options Are Friends, Not Foes
Surveys show that many grain producers aren't comfortable with using options; however, options can be a helpful tool for managing risk and trying to enhance profit.
An option is defined as the right, but not the obligation, to buy or sell an underlying futures contract at a predefined and market-determined price by a certain date. When utilized properly, an option can protect cash or even allow more profits, with limited risk. Options can offset adverse price movements in the cash market or lock in floor prices. Options are a risk-reduction and profit-maximization tool that can augment any farm's risk management strategy.
In the simplest form, there are two options to talk about: calls and puts.
Call options give the option buyer the right, but not the obligation, to assume a long position in a particular futures contract at a specified price for a specified period of time.
Put options gives the buyer the right, but not the obligation, to assume a short position in a particular futures contract at a specified price for a specified time.
For the most part, as a farmer, it is probably wise to primarily be a buyer of options since buying options has limited and known risk, and unlimited profit potential until expiration.
Selling options, on the other hand, involves unlimited risk and a maximum profit equal to the premium received for selling the option. There are times, however, when selling a call can have its advantages. One of those times is with the Bonus Target contract, where long cash is the offset to the short call, as described in my Market Matters column on June 6 describing such a contract.
Read that blog here: https://www.dtnpf.com/…
In the corn market, it would seem that much of the bad supply news is in the market already, while demand -- which has been dismal -- is still up in the air. Yield, production and harvested corn acres all have a chance of going lower in September and October once the objective results come in.
Once you have corn contracted -- and that can be an unpriced contract, a basis contract or a priced contract -- your cash grain firm will often allow you to attach options to those contracts.
For instance, as of Friday's close, you can buy a December corn $3.60 put for a 10-cent premium or a $3.50 put for a 6-cent premium. While that sounds costly, you can also sell a December $4.00 call for a 6-cent premium in combination with either put.
If you bought the $3.60 put, that allows the right, but not the obligation, to get short December corn futures anytime between now and 89 days (Nov. 22 expiration for December options) from now at $3.60.
If you simultaneously sold the $4.00 call, your cash corn would be the hedge against the sale of the call. If December corn goes above $4.00 by Nov. 22, you would be priced on your futures at $4.00. Basis is determined separately. If December corn went below $3.60, you would be priced at $3.60 futures less 4 cents or $3.56. You paid 10 cents for the $3.60 put, but sold the $4.00 call and collected 6 cents, for a net cost of 4 cents per bushel. So, in effect, you are protected below $3.56 futures and are willing to sell your cash at $4.00 all for a cost of 4 cents, leaving the upside open for 31 cents (figuring Friday's $3.69 close).
If you're willing to risk $3.50 on the downside, and still be satisfied with selling at $4.00 futures, then buying the $3.50 put and selling the $4.00 call could be done for zero cost. Your futures price will be no lower than $3.50, but your upside is capped at $4.00 (the strike price of the sold call). A cheap way to get some downside protection, while leaving some upside potential.
A more costly alternative is that you can buy the put alone and be protected to the downside, while leaving the upside completely open until November in the event of a bullish surprise.
Perhaps one of the best reasons to buy options is that few people are bullish at the moment and option premiums are cheap. Much of the bad news is already in the corn market. Options, in their simplest form, are not something to fear, but a tool to utilize. And, more often than not, your cash grain company will accommodate your desire to protect your investment with the potential to add to your profits.
If you don't feel comfortable directly buying and selling options, you may want to reach out to your local grain company for similar cash contacts for consideration.
Dana Mantini can be reached at email@example.com
Follow him on Twitter @mantini_r
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