October 18, 2022
Producers looking to market their crops through futures and options often feel mystified as they try to grasp the perceived complexity of these tools.
Yes options can be tricky, especially if you’re referring to advanced investment strategies with curious names like Condors, Butterflies, Jelly Rolls, Conversions, and Reversals. All are options plays that are practiced by professional traders. Yet, none of these apply to the ways in which farmers can capitalize on their use when marketing their crops.
Producers can benefit immensely from simply breaking down the options model to its basic building blocks -- calls and puts -- then using the underlying limited risk aspects of purchasing those calls and puts to add value to their annual budgets.
Options can be used for hedging and speculating. Aside from both being very common investment strategies, these actions are quite different. Speculating in grain futures and options involves trying to make a profit from a commodity’s price change, whereas hedging attempts to reduce the amount of risk associated with that commodity price change.
What is the entity that connects these two ways of thinking? Volatility. It is the term that seems to define the most abstract part of farm marketing.
Simply explained, volatility is measured by the day-to-day percentage difference in the price of a commodity. But it’s obviously far more intriguing than just a simple definition. The degree of variation, not the price level or price direction, defines the volatile market.
Speculating embraces volatility while hedging confronts volatility. Farmers can speculate using the limited risk, unlimited reward aspect of buying options to leverage profits based upon the crazy movement we’ve seen in the past two years. Or they can hedge, using that same limited risk with the open-ended aspect of buying calls or puts to protect commodity price levels that are desirable for their farm budgets right now (but might not be anywhere near those levels in a month).
Either way, the leveraged aspect of long options strategies can make quite a difference in your ultimate profitability.
We prefer to use options to hedge against the forces of volatility, because farmers for the most part are concerned with growing their crops and selling those crops at favorable levels year in and year out. They want to take as much uncertainty out of the equation.
This is especially vital when confronted with increasing input costs, weather surprises, shocking Macro headlines, and all the other completely unpredictable factors that have never been more prevalent than right now.
Limited risk call options
Re-owning with limited risk call options allows the farmer who has made a cash sale that extra opportunity to benefit from 2022-23 commodity prices that have been volatile enough to surprise even the most astute prognosticators. And using put options to set floors at levels producers could only have dreamed about 2-3 years ago, without sacrificing the opportunity to sell their cash grain at much higher levels if the market continues to surprise with upside moves.
Options keep you in the game and let you sell when you’re ready, not when you have no choice based upon budgetary or market constraints.
Timing is everything when you are running an operation based on annual cycles. Volatility becomes your friend, not some mysterious market force to be feared. It becomes a fortunate presence that gives you a chance to improve your standing as a producer and provide you with knowledge and foresight for years of consistent successful farming.
Take the time to ask questions and learn what implementing options can do in your unique situation.
Contact Advance Trading at (800) 664-2321 or go to www.advance-trading.com.
Information provided may include opinions of the author and is subject to the following disclosures:
The risk of trading futures and options can be substantial. All information, publications, and material used and distributed by Advance Trading Inc. shall be construed as a solicitation. ATI does not maintain an independent research department as defined in CFTC Regulation 1.71. Information obtained from third-party sources is believed to be reliable, but its accuracy is not guaranteed by Advance Trading Inc. Past performance is not necessarily indicative of future results.
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