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What the pros don't tell you

Agriculture.com Staff 01/26/2007 @ 8:57am

In a volatile market like I expect to see this year, options are a valuable tool to allow an individual to take positions in the market with limited risk. The ability to know how much capital will be needed in advance may mean the difference between executing a workable marketing plan and missing very good opportunities because you did not take action.

I know that a lot of people do not like options because of the premium cost and the fact that options tend to expire worthless, resulting in the buyer losing the premium money. Principles that came out in the "Launching Your Marketing Plan" workshops this winter give an idea of how options can be managed to improve the odds for the buyer.

The first principle is that option premiums drop faster for out-of-the-money puts than they do for out-of-the-money calls. As any option gets further out-of-the money, the premium goes down. For example, today December corn futures are $3.99. Premiums for four dollar puts and four dollar calls are within a penny, at $.43 and $.42 respectively. That is expensive. To cheapen up the transaction, a choice would be to buy two strikes out-of-the-money. In that case, a $4.20 call is $.36 cents and a $3.80 put is $.31. To cheapen even further, four strikes out-of-the-money $4.40 calls are $.31 but the equivalent $3.60 puts are only $.21. For comparable value, the put is a dime cheaper than the call. The odds favor the purchase of the put compared to the purchase of the call strictly on the basis of the cost per penny of value.

Many farmers' experience with options is limited to purchasing calls to replace bushels already sold in the cash market. They want to do it as cheaply as possible, so they buy out-of-the-money. That is almost a sure road map for losing whatever they put into the trade. I will have more on tricks to make option strategies profitable in futures columns.

In a volatile market like I expect to see this year, options are a valuable tool to allow an individual to take positions in the market with limited risk. The ability to know how much capital will be needed in advance may mean the difference between executing a workable marketing plan and missing very good opportunities because you did not take action.

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