Choosing a strategy
Information can be powerful. For many producers, knowing their choice of marketing tools, as well as how to implement them, is important to their farm business. There are several alternatives that producers have at their disposal to make marketing decisions. Specifically, we will use examples of grain producers who may currently be either short futures or long PUTS. The first objective is to understand the functionality of the marketing tool that was chosen.
You need to ask yourself if you are a pure hedger or if you want to manage your positions. If you purchased a PUT option or sold futures with the idea that you want protection right up until you sell your cash grain, then your alternative is to do nothing. So, producers who establish a position until delivery remove positions only once delivery is made. Others prefer to manage positions.
The management of positions can entail many different alternatives; we will cover some of these. After the market has made a significant drop, for many the best alternative may be just to exit. That is, if you are short futures, buy back your futures. If you are long a PUT option, sell your PUT. If it is deep in the money, illiquid and has little or no time value, then consider exercising your PUT and establish short futures. Then, buy futures in the same month to offset your short futures. You will now be out of the market.
Another method is to use a stop or stop close only order against your position. A stop order is simply an order that stops the risk or keeps a gain. A stop order placed in either futures or options is an order that is triggered if prices trade at or through this level. It then becomes a market order which, by definition, gets the best price as soon as possible. A stop close only is generally executed on the close only. The goal is that you are not stopped out due to a price spike during the day but where the market sits at day's end. Both stop and stop close only orders have pros and cons, but both can be used to manage positions.
Another method to exit short futures or long PUTS is to place a price or limit order. As an example, if you are short December corn futures and believe futures will move down to $3.00, place a limit order at $3.00. You now have an order that is working for you. If the market moves down through this level, you will exit your short position. The objective there is to, in a sense, make your own luck. It is not unusual to see a big sell-off during the day, only to have prices turn around by the close and finish higher. If you use a limit order on a day like that, you made your own luck by being in the right place at the right time without having to keep a vigilant eye on the market.
Sometimes, it is prudent to use a combination of stop orders and limit orders. If you are short futures, place a limit order below the market to exit shorts and place a buy stop above the market as a trigger point. If one order is triggered, it is important to cancel the other order, or you run the risk of a double fill.