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Courage Calls

Agriculture.com Staff 01/20/2006 @ 1:10pm

There has been considerable discussion on the 'Marketing' talk page about buying courage calls as a strategy for pricing new crop grain. It is a legitimate strategy that I have used several times. However, my approach is different than anyone has discussed on the site.

Looking at the current markets and long-term seasonal charts, it is easy to see that prices are low and are normaly low in January and February. That would make it seem logical that this is the time to buy call options to protect anticipated sales later in the year when prices are usually higher. In evaluating this approach, however, there are two factors you need to consider.

The first factor is that in purchasing options now you are buying a lot of time value. The futures price several months down the road might be higher, but the call options might be cheaper. Time value can result in the option premium going the opposite direction of the underlying futures price.

The second factor is that in buying the call now, you are assuming that the futures price will be higher, giving you the opportunity to make sales later on. While this is the normal direction of the market, this might be the unusual year when prices do not rally in the spring. If that happens, your premium money is wasted because you have not priced the grain.

You must remember that your goal is to get the grain sold. Buying the call option does not accomplish that. If you pay an option premium and do not get the grain sold or get it sold at a lower price, you have not accomplished your goal. You have reduced your final price, not enhanced it. Times when I purchased the courage calls in January, I wasted my money.

My preferred approach is to make the sale with futures or cash forward contracts during the late winter or early spring when prices are favorable. The research we did in developing the 'Winning the Game' workshops shows that selling corn when December futures are over $2.40 and selling beans when November futures are over $6.00 have high odds of success.

The normal price pattern is for a rally from March 1 through early May. Usually there is a time after crops are planted and before weather scares develop when prices drop. That is a good time to purchase the options. Buying the calls later rather than sooner offers that additional advantage of knowing exactly what price level you need to protect.

In 2005 prices did not pull back as they usually do in early summer. That made waiting to buy options a nerve racking experience. In 2003, the market acted very nearly as I expected. That summer call options on November beans got quite cheap around the first of August and I was actually able to lock in a profit on the sale, even though November futures eventually went over $8. The calls saved me from a huge loss in that market.

There are times during the marketing year when taking a little risk pays off handsomely. A short period of having new crop grain sold in the early summer is one of those times in most years. The beautiful thing about options is that there are so many strike prices and so many delivery months, you can tailor a strategy to almost any need.

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