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Option-writing opportunities

Agriculture.com Staff 06/19/2009 @ 1:28pm

Frequently we hear farmers say there is not much opportunity in the markets, especially in sideways price patterns. Many of these same farmers say that options are too high-priced to buy. Understanding option value is critical to have a basic utilization of options in your farm marketing decisions - at least it should be. If you believe options are overpriced or if looking for opportunity, you may want to explore option writing.

When using options, you will want a working knowledge of how time plays a role in option value. Options that have more than 90 days worth of time value will see little time-price erosion from a day-to-day standpoint. For options with less than 90 days of time value, each passing day that the futures market is not working in favor of the option is one day less of "chance". If you purchase calls for re-ownership or puts for protection with less than 90 days, you may be disappointed that, when the market moves, your option is not gaining value as fast as you perceive it should. That is a reflection of your option fighting against eroding time value - a benefit to the option seller.

There are different occasions where you may want to incorporate option selling. One strategy, called the short strangle, is a position when you sell both a call and a put which are out of the money. The expectation is that futures will move in a sideways pattern and both of these options will lose value. Remember, as an option writer, declining premium is your goal. When you sell an option, your account will show a credit and debit for the same amount. As the option loses value, your credit stays in place but your debit reduces, eventually down to zero if the option expires worthless. At that time, your credit will be maximized.

Another potential and, perhaps, salient strategy is for producers to sell options against the historical movements of markets. As an example, if corn or soybean prices usually move higher into spring or early summer and typically lower by fall, you should consider selling call options in late spring or early summer. If you have unpriced inventory and sell a call option, bear in mind the only way a short call can gain value against you is if the market rallies. We view this situation as a win-win. If prices fail to rally through the strike price by the expiration date, you collect all the premium. If prices trade in a sideways or lower pattern, you collect premium. If prices rally through the option strike price at expiration date, the owner of that option will exercise this position, and in turn, you will be assigned a short futures. You are hedged at a level higher than at the time you sold the option. You still keep all the premium. Your net worth went upward due to the gain in cash grain. Selling out-of-the-money March corn or soybeans calls against stored inventory after harvest is a great way to challenge futures to rally. This collection of premium can help pay for storage.

Bottom-line, there are many variations of strategy to utilize options other than just purchasing. We encourage producers to be aware of the functionality of options and how time value as well as volatility play a role in option pricing as well as risk. Selling options has unlimited risk with fixed potential. Margin requirements will also require cash flow. Often it is said there is opportunity if you look for it. This is the case with options.

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Scott Shellady: Options 101