Using short-dated option contracts
A marketing tool that farmers can utilize to avoid spending dollars on long-term time value is called a short-dated option.
What is a short-dated option?
First, let’s start with the definition of a traditional option. When trading options, you have choices of which month to purchase. As an example, a corn producer may choose to buy a December corn put to establish a price floor. He may wish to do this well before the crop is planted. By purchasing a December put, he owns an instrument that gives him the right (not the obligation) to be a seller in December corn futures until option expiration in November. This a traditional option.
A short-dated option in the corn market has an underlying instrument, December futures, to derive the value of the contract. The biggest difference is the shorter time window. A short-dated March corn put has the time value window of a traditional March option but can be exercised into a December futures contract. In soybeans, the contract used for short-dated options is November.
Why use a short-dated option? In most cases, the farmer who buys short-dated put options is concerned with protecting the value of new crop prices in a more close-up time window. The big motivator is the belief that the market could make a move sooner than later, so why spend money on time value? The key is knowing, as an owner, you can exercise this option if it is in the money at expiration, which provides the ability to be in the futures market until the last trading day, which in corn is December and for soybeans, in November. The farmer who thinks soybeans will peak in early winter might buy a March short-dated put with a February expiration date. Upon expiration date, one of two events will happen: The put will expire without value or it will have intrinsic value. If there is intrinsic value, the producer can then sell this put through the exchange or exercise it, turning it into a short November futures contract. In the case of call options, an end user of corn may want to buy a short-dated call to protect against upward price potential.
Short-dated options are yet another tool that farmers can utilize to shift risk and take advantage of opportunities. The key advantage is the ability to exercise into longer-term futures while spending less money on time value, when comparing the cost to a traditional option. Be sure to have a conversation with your advisor who can help guide you to use the right option for your risk tolerance and goals.
If you have comments, questions, or suggestions, contact Bryan Doherty at Total Farm Marketing. You can reach him at 1-800-TOP-FARM, 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.