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Why Use Call Options
Call options are fixed-risk marketing tools used by both producers and end users of commodities. Those who purchase call options are buying the right, but not the obligation, to be long futures. Another way to view this is to suggest that you're buying insurance against higher prices. There are many different reasons why someone may purchase call options. In this Perspective, we'll look at three reasons why these may be valuable tools for farmers, and should be considered and incorporated into your marketing strategies.
The first reason to purchase call options is for grain and livestock producers to participate in a rally, even when they have made some type of cash sale arrangement. Typically, farmers will forward contract expected production. Once production is forward contracted, they are no longer eligible to participate in a price rally, nor will they lose value on their product. However, should a price rally occur, call options (when purchased against forward sales) act as a retained ownership. It is not unusual for farmers who forward contract corn in spring to purchase call options in case summer weather is adverse and prices move sharply higher. Though the sold corn can no longer appreciate in value, the farmer can experience an increase in his call option value, should prices rise. If he exits this position with a gain, he can then apply this to his forward sale price.
The second reason to purchase call options is to provide confidence. In this case, you buy call options on anticipation of prices rallying, and then you will sell the crop. Often farmers know the price at which they want to sell. Yet, when prices reach their targets, they start to second-guess themselves. What if prices keep moving upward? Because you already own the calls, the discipline to keep orders in place is strengthened.
A third reason to use call options is to shift risk, particularly for feed users that buy grains and grain products. When grain prices make a big move, it is typically weather-related, and the move can be swift and fast. In 2012, corn prices rallied over $3.00 a bushel in less than 60 days. Unless you were in the market before the rally started, upward price activity was so fast that it was difficult to get in. You didn't want to buy too high and have the market fall apart. Buying calls against feed needs when prices are low could be done every year prior to spring, so that all potential weather rallies are managed.
These examples are only a few of how a marketing tool, in this case a call option, could help facilitate decision-making so that the emotion is taken out of the process, while still being smart and productive from an economic viewpoint.
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.