Soybeans rally $1.00, farmers now have choices, analyst says
After more than a $1.00 rally in soybeans and $0.45 in corn futures, you have choices.
Should you sell or should you store?
What if you feel prices could go down and you want to establish a price floor, yet you also feel there is some upside left before a top is in place.
Harvest is quickly approaching. What strategy might best suit you in this scenario?
If you purchase a put, you are buying the right (not obligation) to sell futures. The concept is comparable to buying insurance. If prices go lower, you can use your put to establish a price floor. To reduce the cost of a put (determined by time, proximity to futures price, and volatility) you could consider selling a call option.
When selling a call option, you are betting prices will not reach the strike price of the sold call and, therefore, the option premium erodes to zero on expiration date. In this scenario, you would have collected all the premium which helps to offset the cost of your put. Or, you are willing to accept that the buyer of the call option exercises the call (turns the position into a long futures) and you are assigned a short futures at the sold call strike price.
You are now hedged in futures and you collect the short call premium. In this scenario, the put you purchased would lose its premium by expiration, as futures would have to be higher than the put strike price.
Let’s look at an example of a fence with three scenarios, showing how different futures prices at expiration will affect your final price. For simplicity, we’ll round to even numbers, use a zero basis, and not assign commissions or fees. Keep in mind these will be factors if you enter the market.
Example: July corn futures are trading at $3.80. You purchase a July $3.80 corn put for 22¢ and sell a July $4.30 call for 10¢. At expiration, one of three scenarios will occur.
Scenario #1: If July corn futures are below $3.80, the put will have value and the call will lose all its value. Say corn is at $3.30. The $3.80 put would be worth 50¢, the call worth 0¢, for a net gain of 38¢.
Scenario #2: If corn futures at expiration are between $3.80 and $4.30, both options lose all their value for a net loss of 12¢.
Scenario #3: If futures are above $4.30, say $4.60, the put would lose all its value and the call be worth 30¢. However, you would be assigned short futures at $4.30. The net would be short futures at $4.30, 10¢ gain on the short call and loss of 22¢ on the long put. Keep in mind, your unpriced cash corn will have benefitted from $3.80 to $4.60. The net: 80¢ gain in cash ($3.80 to $4.60), 30¢ loss in futures, 10 cent gain from the short call, 22¢ loss from the put for a net selling price of $4.18, which allowed for a capture of an additional 38¢ from $3.80.
Remember that commissions, fees, and basis will affect your final net price in all three scenarios.
Fences are one of many strategies that could be part of your marketing toolbox. Some of the potential risks are initial as well as maintenance margin requirement if the short call is increasing in value.
By selling a short call, you are effectively capping gain of your unpriced commodity at the strike price of the sold call. Yet, should prices remain under the sold call strike price, you will have reduced the cost of your put, increasing your price floor compared to the outright purchase of a put by itself.
Consult with your advisor before establishing any position to be sure you have transparency of dollar requirements and risk.
If you have comments, questions, or suggestions, contact Bryan Doherty at Total Farm Marketing. You can reach him at 1-800-top-farm, extension 444.
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.