Cover cash sales with futures and options, analyst says
Here is an interesting question. When can you afford not to sell? Say what? When can I afford not to sell? Most might answer that question with an “I don’t know.”
The answer is probably when you cannot live with yourself for bypassing prices you know you should take. Your instinct to make a marketing decision is probably correct, yet sometimes not be easy to execute. Often emotion and other outside influences come into play. This is especially true in a year like we are currently experiencing, where shrinking grain supplies and growing demand create an environment of high volatility. One day your thoughts are bullish and one day they are bearish. Strategy is your best bet to navigate uncertain waters.
If your instinct is telling you to sell, then sell. However, you also realize that prices could continue higher, and may even be explosive if weather is a factor. Cover your cash sales with tools that allow you to participate. We will explore several and the risks associated with each.
Buying futures. This strategy provides ownership, yet has the tagline of the same risk as owning cash. Unless basis is extraordinarily strong, selling cash and re-owning with futures does not really shift any risk. You would, if you are that friendly to prices going higher, be in the same position as owning unpriced cash. Let’s say no to buying futures if you want a fixed risk re-ownership.
Buying a call option. The owner of a call option has the right (not obligation) to own futures. Risk is fixed to the cost of the option (called premium) and commission, fees, etc. This strategy makes good sense. You sell cash and have re-owned with a fixed risk tool. You will have to determine what call (month) to buy and how much are you willing to pay. In volatile markets, call options will be more costly than in less volatile markets. Strike price is the level of the call. You will need to decide if you want to buy a call with a low strike price (near the futures price) or spend less on a higher strike price call.
Bull-Call Spread. This is where you buy a call option with a strike price near the futures and, in the same contract month, sell a higher strike price call. Your net cost and risk are the difference between what you pay and collect, less commission and fees. This strategy is a cost saver. You are buying a call option with time value and volatility priced into the cost, and you are selling a call option with time value and volatility priced into it. In other words, they cancel each other out. Your risk is fixed, and so is your potential gain. The maximum the spread can make is the difference between strike prices less costs.
Short-dated Call Options. Short-dated options can be purchased and are used for a shorter time period. In corn, they reflect the December futures; in soybeans, the November. These are generally purchased when you want coverage for a report or perhaps the next two weeks of weather. These are good strategies for specific time periods. Risk is fixed to the premium paid plus commission and fees.
These are four strategies. Each has its own merits and risks. Be sure, before entering any strategy, that you have a full understanding of the risk that may be incurred. If used in conjunction with cash sales, you accomplish the task of selling (shifting risk) and retaining the ownership for more upside price opportunity. The growing season ahead will likely be volatile for prices. Covering cash sales is one method to tame volatility and emotion using strategy.
If you have comments, questions, or suggestions, contact Bryan Doherty at Total Farm Marketing. You can reach him at 1-800-334-9779, extension 300.
Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Past performance is not necessarily indicative of future results.