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New products control risk

Grain marketing is no easy chore, especially when you try to sell a crop before it's even planted. Marketing strategies are virtually infinite, but the tools themselves are fairly straight-forward: futures, options, the cash market, and hedge-to-arrive.

But earlier this year, the CME Group, which owns the Chicago Board of Trade grain futures exchange, launched a number of new traded products that might augment your marketing toolbox.

Most of these products were launched in the spring or summer. The early adopters seemed to be the floor traders and the big commercial grain companies that were best positioned to take advantage of these new contracts.

At the farm level, producers and their advisers are just being introduced to these products and how they might be used. Similar to when standard options-on-futures were introduced a couple decades ago, farmers and brokers are free to develop creative marketing strategies with these new contracts.

The CME hopes farmers will participate in trading these products. The economists and statisticians who developed these contracts spent a lot of time trying to tailor the products to attract both buyers and sellers, in roughly equal amounts, says Fred Seamon, who participates in that effort in his role as associate director for commodity research and product development at the CME.

“There's a lot of interest in these options because you don't have to pay a lot of time premium.”

“When we research an industry for new trading products, we like to find what we call natural longs and natural shorts,” he says.

Several new products – such as weekly options and calendar spread options – are attracting good volume in just their first year of introduction.

Weekly grain options

Weekly options mean that grain futures now have an option contract expiring every week of the year. They are short-term options that are no more than four weeks long.

The exchange has long had standard options that track the staggered schedule of the futures months (such as July, September, and November). Later, the exchange added serial options that fill in the nearby months that were missing between standard options.

Weekly options are similar, filling in the nearby schedule so that the next four weeks always show a Friday-expiring option. When one expires, a new one is added, always offering four options over the next month.

There's a lot of interest in these options because you don't have to pay a lot of time premium. Farmers can use them, for instance, to provide low-cost price protection around the volatile planting and harvest seasons, possibly even the corn-pollination season. If there's a three-week heat dome building over the Midwest, there's a three-week option to match. Other parties are using them actively to provide short-term protection near a key USDA report.

Citing the trade's acceptance of weekly grain options (WGOs), the exchange later added weekly options for cattle, soy oil, and soy meal.

Calendar spread options

Calendar spread options (CSOs) are also attracting volume in Chicago. They track the difference between two different futures months, such as July vs. November soybeans or September vs. December corn.

Marketing strategies have long involved a spread trade that buys or sells a nearby futures while establishing an opposing position in a deferred contract. CSOs allow the spread to be established with just one option purchase.

Grain elevators can use these options to hedge stored grain, and farmers can use them to hedge grain in storage or in the field. But the biggest users might be big commercial buyers of grain.

“Crops are harvested just once a year, but processors need their grain deliveries spread out across the calendar. Futures prices are used to help allocate that crop across the entire year – but not without risk,” says Seamon. “Now with these new CSOs, processors or any one else exposed to that calendar risk can utilize an options strategy to help hedge that risk.”

“Traders call VIX a measure of interest in the market.”

Calendar spread options combine a traditional two-futures buy/sell spread into a single option trade. And as an option buyer, you have no margin calls.

Bean-corn ratio option

Another new product is the soybean-corn ratio option. If corn is $7 and soybeans are $14, for example, the soybean-corn ratio is 2.

With this new option, you can bet on whether that ratio will widen or narrow. It doesn't matter whether prices generally go up or down, your bet is on the spread between corn and soybean prices.

Seamon expects activity in these options to pick up in the winter and spring when corn and soybeans are competing for acres.

VIX index tracks volatility of corn and soybeans

The Exchange has begun computing a VIX volatility index for corn and soybeans. This is a general volatility measure of the corn and soybean markets, based largely on the implied volatility for individual option contracts.

Each option has its own implied volatility, and VIX is computed by combining those individual measures.

Traders call VIX a measure of interest in the market. If there's a lot of volatility, it can suggest that there's a lot of fear and uncertainty in the market.

If volatility is low, it suggests complacency among market participants. Some advisers suggest that when fear or complacency reaches its extremes, the mood is about to shift. VIX allows for measuring those moods.

Corn and soybean futures/options begin trading at 9:30 a.m. each weekday. Based on that trade, the Exchange starts computing VIX at 9:45 a.m. and updates it every 15 seconds.

Seamon says the CME is looking at developing a wheat VIX, and it's possible that the Exchange may develop tradeable VIX contracts for these grains.

DDG futures help both ethanol and livestock

In April 2010, in an attempt to serve primarily the ethanol and livestock industries, the CME launched a futures contract consisting of 100 tons of dried distillers' grain (DDG).

The contract calls for a minimum 26% protein and 8% fat, and a maximum 12% fiber and 11.5% moisture. Deliveries are based on prices at Chicago and Council Bluffs in western Iowa.

To serve the ethanol and energy industries, the CME also has a 29,000-gallon ethanol futures contract. The contract equals roughly one railcar of denatured fuel-type ethanol.

By Andre Stephenson

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