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Buying a Call Option Makes $ense, Analyst Says
With grain markets on the defensive since mid-summer, prices have retreated low enough that good value, from a historical perspective, exists for the end user. Just as important, those who forward contracted grain from higher prices may want a means to retain ownership of these bushels. For those who haven't forward contracted but would like to sell on a rally and need a boost of confidence or a tool to be a disciplined seller, you should look at call options.
Call options provide the opportunity to own futures but not the obligation. In this Perspective we'll consider how using a call option can benefit feed buyer, those who have forward contracts in place, and those who intend to sell ahead.
From a feed user perspective, prices have retreated significantly in corn futures as well as soymeal. The benefit, of course, is that prices on the Chicago Board of Trade offer good value from a historical perspective and are nearing what many might term the harvest low. This year's crop for many producers has a long way to go from a production perspective as nearly 35% of the corn crop was planted after June 2. Weather throughout the entire growing, as well as harvest season, will be needed to mature the crop properly. An early frost is certainly a concern. Farmers should consider purchasing December corn calls if they want upward price protection between now and November 22, option expiration date. If, for example, a frost came early and effected a significant portion of the corn crop and futures rallied, the call option you purchased can gain value and offset which will eventually pay in the cash market for grain. A simplistic example would be purchasing a December $3.80 call for 6-1/2 cents. If corn futures by November 22 rally to $4.80 this option would be worth $1.00 less your cost of entry and commission.
For those with forward contract, they're putting themselves into a re-ownership position. If the call option gains value, you have the option to turn it into a long futures or sell it into the marketplace. If you sold corn on a hedge to arrive contract at $4.00 December futures and purchased a $4.00 call, you would have the right to own corn futures at $4.00. If corn futures moved to $5.00 there would be a gain of $1.00 on the option. Your net gain would be the option value minus the cost bracket (premium bracket) and commission. As far as approaches, typically there is not a lot of reason for prices to rally but as pointed out above with such a large portion of the crop maturing so late, anything may be possible this year. Owning a call option against forward contract or grain may make a lot of sense to not only give you a peace of mind that you are prepared if prices move higher but to actually provide return on investment should the market move upward. With your risk fixed, this may be a good way to participate should futures rally.
For those wishing to make sales but not on a current prices, setting targets above the market makes a lot of sense. Should prices rally and you target is hit, you sell at a higher level. However, if futures continue to move higher a couple of things might happen. One, you might have regret that you have now sold too low. Second, while you may want to sell more your confidence to sell may be abandoned because your first sale is now considered too low. By purchasing a call, if prices rally you now have the discipline to keep your order in place and allow it to trigger. You already have ownership of those bushels. Should prices continue to move higher, your call is gaining value and you feel mostly whole. That should provide additional confidence to sell more bushels. While this seems simplistic in nature, in reality trying to make additional sales if you feel you have already made a mistake making sales is a big hinderance to many farmers making clear unemotional decisions.
If you have comments or questions or would like to discuss strategy for your operation, contact Top Farmer at 800-TOP-FARMER extension 129 and ask for Bryan Doherty.