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Options are an option

Scouting fields this week, again, proved to be a frustrating experience. The corn is drying at a record pace. Most fields that were planted at normal time are dry enough to harvest with very little need of artificial drying. For the first time in my farming career, I will have an adjuster here to assess the damage from a wind storm on August 8. This is the first year I have carried hail and wind insurance, because I have never had hail damage. And wind damage has occurred once in ten years. Thanks to a persistent crop insurance agent, my first experience is likely to be a good one. 

I have had calls from farmers who are concerned about the risk of prices dropping and taking away some of the price protection now bid into soybean and corn futures prices through their crop insurance policies. With $12.55 set this spring, for November soybeans, and $5.68 for December corn, it is easy to understand why individuals are concerned about losing the higher price on their crops, if prices would happen to drop catastrophically. 

I have been watching options prices all summer, for an opportunity to use them as a risk management tool. Until now, I have felt that the premium cost was too high for the amount of risk covered. With the passage of time and increase in futures prices, I think that may be changing.

The first and most obvious strategy would be to buy a put option. For instance, a $16.30 'at-the-money' put option on November soybeans was quoted Thursday at 77 cents. Earlier this summer an 'at-the-money' option on November futures was over a dollar. Similarly an 'at-the-money' put option on December corn was 53 cents. Earlier, an 'at-the-money' corn put option was 60 cents for a much lower strike price. 

A way to cheapen the premium cost is to use a 'bear' put spread. In that strategy, an 'at-the-money' put option is purchased and an 'out-of-the-money' option is sold. The premium on the sold option will offset a portion of the premium cost. This strategy limits the potential profit. However, it has a higher probability of being profitable than simply buying a lower strike price put. 

Another very simple strategy is to simply sell a futures contract at today’s price of $8.07, for December corn, or $16.25 for November soybeans. Doing that locks in the price $3.70 higher then the spring price for November soybeans and $2.39 for December corn. If you are comfortable that the price cannot go much higher than it is today, that is a very workable strategy. A variation of this strategy is to buy an 'out-of-the money' call to cover the upside potential, if futures prices continue higher. The profit potential will be reduced by the amount of the call premium. However, the limitation is less than with the spread mentioned earlier. 

None of the strategies I have described is risky if used to hedge the price of the 2012 crop. The risk is in getting the order filled now and at the time the fall price protection is set for crop insurance. If you do not understand options, I advise starting small until you are comfortable with the process.    

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