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Think percentages

Agriculture.com Staff 07/18/2008 @ 11:54am

In today's volatile markets, it is important for farmers to understand the cost (premium) of options as a percentage of the value of the entire contract, not just focus on cost alone.

With record high grain and bean prices, we are somewhat surprised by the number of producers who are expecting to buy PUTS or CALLS for the same cost they may have spent when futures prices were much lower. With increased futures prices and volatility, option prices will also increase in pure terms, but not necessarily in percentage terms.

A PUT option will usually cost about 10% to 12% of total value of a futures contract. As an example, in past years when corn futures were at $2.80, most farmers recognized that spending roughly 10% to 12% of the value of a 5,000 bushel contract, or about 28 to 30 cents, for a PUT was reasonable. With corn prices near $6.50, looking to spend approximately 65 or 75 cents for a PUT may seem too expensive. This is where cost analysis using percentage relative to the value of the underlying futures contract is necessary. As of this writing, December corn futures are trading at $6.50, and a $6.50 PUT is listed at 53-1/2 cents, or 8.23% of the total contract value. Still too expensive?

The difficulty for many farmers to appreciate is the cash flow requirements for options. A strong relationship with a lender who understands the value of marketing strategy and options is a must! The ability to understand these costs and relate this to your lender is important for your operation. Lenders who understand option costs and functions are better suited to help you with your marketing finances. Options are powerful marketing tools. Become knowledgeable or hire someone who is.

If you have questions, comments or you would like to discuss your marketing, contact Bryan Doherty at Top Farmer at 1-800-TOP-FARM ext. 129.

In today's volatile markets, it is important for farmers to understand the cost (premium) of options as a percentage of the value of the entire contract, not just focus on cost alone.

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