When I made my marketing plan for 2007, I decided that I would use options instead of futures or cash contracts to lock in the price of corn.
I was making this plan because of the possibility of crop failure or prices going a lot higher as the year progressed. My idea was to purchase put options to lock in a floor price, leaving the top open. Keep in mind that I raise only 126 acres of corn. Premiums are a factor only as they affect profit, not as they affect cash flow.
As December corn futures prices rallied, the premiums were large, but the profit potential also great. The price peak in February took me by surprise because February is not usually a good month to make sales of either corn or soybeans. Nonetheless, after the price started to slip, I put in an order to buy a December $4.00 put for 32 cents. Unfortunately the futures price went down and put option premiums went up. I did not get the option bought.
Finally, near the end of March prices again rallied and put option premiums dropped. I decided I did not want to miss that rally, so I put my order in at 36 cents. On March 26, corn futures took a nose dive again. However, before heading lower, the price began the day higher. I got my option bought. I thought that the rest of the plan would be simple. It was for a while.
December corn futures prices went up and down a couple more times, but only once got close to the top made in February. By the middle of the summer it was obvious that we were going to raise some corn and prices were quite a bit lower. My put option was looking really good. With futures at $3.30, the put was worth at least 70 cents. One of the things I stress in options workshops is that options are almost infinitely flexible.
I had been holding a small amount of cash corn just in case there was a complete crop failure and prices skyrocketed. By the middle of July it was obvious that was not going to happen. I sold my remaining corn for $3.06. However, I also thought it might be wise to take some of my put option profit off the table. There were two ways to accomplish that. One was to sell the $4 put and buy a lower priced one. The other would be to buy a call to offset the put. I decided to try both.
I put in the order to sell the $4 put and buy a $3.60 put for a net of 37 cents. I was too greedy. The order never got filled. As corn prices rallied, the profit potential for this spread got smaller and smaller and I was left with the put option premium becoming less.
The strategy of buying a call option would have caused me to have more premium money invested. One way to avoid this was to buy a low strike price call and sell one with a higher strike price. I put in an order to buy a $3.50 call and sell a $4.00 call. That order was filled at a cost of 12 cents.
I figured that if the price subsequently rose, the profit from the call options would offset the premium on the put option. I would then have my price protection free. Selling the $4.00 call would limit my potential for profit on the call trade. Since my goal with that part of the strategy was to offset the cost of the put option premium, I was willing to take that chance.