Selling Corn and Reowning It With an Option Contract
For those new to using options, or looking for a quick review, this perspective will study a call option.
A call option is an instrument traded at the Chicago Board of Trade that is used by both farmers and speculators. A farmer may use a call option to retain ownership of sold grain. Or, if purchasing corn to feed livestock, a farmer may use a call option in order to shift risk against future purchases of actual grain.
A speculator would purchase a call option if they believe prices will move higher. A speculator may also sell a call option anticipating prices will not move higher, and thereby collect premium.
We’ll start with basic terminology. Premium is the amount of dollars paid for a call option. The price of a call option is determined by the amount of time left in the life of a call option, the proximity to the underlying futures contract, and volatility. Call options are often viewed much like auto insurance. If you’re purchasing six months of auto insurance, this will cost you more than if you are purchasing three months.
Call options are traded each day at the Chicago Board of Trade, and prices are determined through a price discovery system in which buyers and sellers come together to create a transaction. Once this transaction has occurred, it is a published price.
For example, a corn producer who sells his corn in the spot market after harvest, and believes prices may go higher, could purchase a call option for the chance to be long the market and retain ownership. The call option purchased gives the farmer the right to own futures, and not the obligation. Should corn prices move higher, the farmer can either sell the option back to the marketplace, or exercise the option, which means convert it into a long futures position at the strike price purchased.
A strike price is the level at which a call option ownership is established. Strike prices are at 10¢ increments. Therefore, if you’re purchasing a corn call option, you’ll be purchasing a strike price of, say $3.60, $3.70, or $4.00.
Investors (or speculators) will purchase a call option if they believe prices will move higher, just as a farmer will do to retain ownership of sold grain. Risk is fixed to the premium, commission, or fees. Risk is unlimited when writing (selling) a call option. If you believe corn prices cannot rally, you might consider selling a call option in order to collect the premium. This is a marginable position, which means you have to maintain an exchange-determined dollar amount in your account. This means you may be required to meet margin call should the call option gain value.
If you are a producer harvesting corn with a high yield and have an overrun of supply, you may need to sell. With corn prices currently trading near $3.50 on December futures, you may also want to reown these sold bushels. Purchasing a call option is one method to re-own with a known risk. Now you just need to determine which strike price, which month, and how much premium you are willing to pay. Have a conversation with your adviser, so they can guide you to the option that best meets your needs.
If you have questions or comments contact Top Farmer at 1-800-TOPFARM, ext. 129.
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.
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Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Hypothetical performance results have many inherent limitations. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. No representation is being made that scenario planning, strategy or discipline will guarantee success or profits. The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Reproduction of this information without prior written permission is prohibited. This material has been prepared by a sales or trading employee or agent of Stewart-Peterson and is, or is in the nature of, a solicitation. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Stewart-Peterson. Stewart-Peterson refers to Stewart-Peterson Group Inc. and Stewart-Peterson Inc. Stewart-Peterson Group Inc. is registered with the Commodity Futures Trading Commission (CFTC) as an introducing broker and is a member of National Futures Association. Stewart-Peterson Inc. is a publishing company. A customer may have relationships with both companies. Accordingly this email is sent on behalf of the company or companies providing the services discussed in the email.