If storing, consider challenging the market, analyst says
If you know you are storing, you also know you are willing to take certain risks. There may be many reasons for storing your grain.
For this article, the term grain will include corn, soybeans, and wheat.
The obvious is to control the flow of grain at harvest to make for timely fieldwork. Who wants to sit in line at a delivery point, especially if the weather is good? Time is money.
Other reasons to store are expected price improvement, basis improvement, or both. Whatever your reason for storing, there is a cost, risk, or both. If storing off-farm, there is usually a monthly charge, and perhaps a dump or load-out fee. Nothing is free. One strategy to help pay for costs is to sell out-of-the-money call options.
Call options are considered out of the money when the strike price is above the current futures price. For example, if December corn futures are trading at $5.30, a December $6 corn call is out of the money.
The purchaser of a call option has the right to be long futures at the strike price they purchased. A person who purchased a $6 corn call in this example has the right (not the obligation) to own corn at $6 on December futures. Call options are often purchased to establish a price ceiling against future purchases of actual grain, or to retain ownership if you sold the physical.
Options are traded at the Chicago Board of Trade and are executed on behalf of a customer through a licensed market adviser. So, who can sell an option? Anyone can who has a brokerage account and is able to meet the financial requirements.
If you sell an option, you collect the premium (paid by a buyer) and you guarantee the buyer (owner) of that option the right to turn this into a long futures position at the option strike price. The seller of an option is also known as the writer.
Risk incurred writing options is potentially unlimited. The exchange recognizes risk by requiring an initial margin (good faith down payment) and potential additional funds called maintenance margin. What it boils down to is the seller of an option has limited profit and unlimited risk.
On the surface, this doesn’t sound too attractive. Yet, if you have grain in the bin, you also have unlimited risk. If you sell a call option against stored grain, the call option gains value (a risk for you) only if the futures market rises. The positive implication for you is that your cash grain can also gain value. So, while you may have the risk of margin call to maintain the sold call position, you also have the benefit of stored grain increasing in value. If the futures price at expiration is below the strike price of the sold call, the call would expire without value and the premium would be fully collected.
Likely the biggest drawback to selling options is cash flow requirements for margin call and a price cap that you have placed against your stored grain. Let’s use our example and say you sold a $6.00 call. At expiration, let’s say corn futures are at $6.50. You collected the premium, however, the owner of the option will exercise it into a long futures position at $6. The exchange will assign you a short futures position at $6. In essence, the loss above $6 on futures will be offset by gains in cash. If one assumes no change in basis, you can see that, wherever corn prices would rally above $6, one offsets the other. In the end, your net selling price is $6 (based off futures) plus premium collected and less any transaction fees incurred.
This strategy is not for everyone. For those who are willing to challenge the market to move higher in price, this may be an excellent way to collect premium, helping to finance the cost of storage. A thorough understanding of the potential and risk must be understood before entering a position. Make sure you have a critical conversation with your adviser.
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.