Farm Progress

While options can be an effective way to manage risks when marketing grains, they’re not without their problems.

Paul L. Hollis

March 16, 2015

7 Min Read
<p>THE OPTION IS the best tool ever invented for the American farmer to become a better marketer, says commodity broker Mark Gold.&nbsp;</p>

While options can be an effective way to manage risks when marketing grains, they’re not without their problems, says commodity broker Mark Gold.

“The No. 1 problem with any option you buy is that 85 percent of them will expire and be worthless. So why would I have you spend money on something that will expire worthless 85 percent of the time?” asks Gold.

(Editor’s note: This is part two of an two-part series on grain marketing, based on a presentation at the Alabama corn and Wheat Short Course by noted commodity broker Mark Gold of Top Third Ag Marketing in Chicago).

When growers buy a put option, they want it to go worthless because they want corn prices to go higher. “We want to be in that 85 percent and watch it go worthless because that means corn prices are higher. But what percent of options had good money in them at some point, and you didn’t take the money out before it went worthless?

“When corn went to $3.18 this past year, if we had a $4 put on it, if we didn’t take out some money when it got down to $3.20 or $3.30, and that option would have been worth 70 cents on that October rally, we would have lost all of that money, and the option could have expired worthless,” he says.

As a commodity broker, Gold says it’s his job to help farmers manage the option as an asset and let them know when it’s take to take money out of it.

“The second problem with the option is that you’ve got to pay for it. You have to write that check, and you might not have the cash right now. Maybe you’ve got the tractor payment coming up or the seed bill is coming due. That’s when you need an ag lender who understands this and is willing to lend you the money. If your banker says he’s not willing to lend you money for something that expires worthless 85 percent of the time, you need a new banker,” he says.

The third problem with the option, says Gold, is that they’re not perfect.

“If you buy the December 2015 put for 25 cents, from $4.20 down to $3.75, don’t expect the value of the put option to increase all that much. As the market goes down, the value of the put will slowly increase. Once it gets under $3.75, it’ll pick up some steam. Don’t expect the options to follow the futures market penny-for-penny. The options aren’t perfect.”

If a grower is “swinging for the fences,” and trying to hit a homerun in grain marketing, he’s likely going to strike out, says Gold.

One reason many farmers don’t use options is that options haven’t been around that long,” he says.

“They didn’t come in until the 1980s, so if you’re 50 or older, it’s not something you were raised with, but younger farmers should be familiar with these and should be working with them, and older guys should take the time to understand options. In my opinion, the option is the best tool ever invented for the American farmer to become a better marketer.”

Gold advises growers to not become speculators and try to out-guess the market. As soon as you hear a commodity broker say these words, ‘I think,’ hang up the phone. I don’t have a clue if corn is going up to $7 this year, or if it’s going down to $2.50. But if you buy a $4 put for 25 cents, you’re spending 25 cents to protect $1.50 of risks. That’s a 6:1 risk/reward ratio.”

Low odds of beating the pros

What are the odds of you beating the pros on the Chicago Board of Trade as a speculator?

“Seven percent of all outside speculators beat the pros in Chicago,” says Gold. “Those are lousy odds, but each of you is probably playing that game right now. If you are storing grain unprotected now, or if you are going to grow grain in 2015 but haven’t sold a pound of it, you’re speculating with it and hoping the price goes higher. The odds that you’re right are 7 percent.

The risk of growing corn in 2015 is that corn can go to $2.40 per bushel. Soybeans can go to $7.80 per bushel, and wheat can go to about $4 per bushel. If any of us marketing gurus knew where the market was going, we wouldn’t be telling you. We’d be long retired.”

This past year, many farmers who had crop insurance didn’t get much of check, says Gold.

Many farmers found out that if they had crop insurance in 2014, they didn’t get much of a check. “The revenue insurance protects the ‘dead’ bushels. If you grow the bushels, and your APH is 160, and you came in at 169 bushels, you didn’t get a check. You’ve always been told that if prices go down, you’re protected. That’s nonsense. You get more bushels, but you get them at a lower price. You have to identify what the crop insurance can do for you. Insurance will protect only bushels you don’t grow. A marketing plan protects your ‘live’ bushels.”

The hardest concept to grasp when buying options, says Gold, is that when you buy that $10,000 worth of options, you want to lose the money.

“It’s like any other insurance. If you have life insurance, you want to lose the premium every year. Everyone has car insurance, but no one wants to get in an accident so they’ll collect on the policy.”

What are the two factors that determine whether or not the expense of the option justifies the risk?

“We have to have at least a 3:1 risk/reward ratio before we’ll buy any option. The No. 1 factor that determines if an option has worth is where prices are historically. Are we in the lower, middle or upper third of historical prices? If we’re in the upper third, wouldn’t that be a good time for you to sell grain or to buy a put option and expect that it would have a good chance of paying off? If you’re selling grain in the lower third of historical prices, wouldn’t that be a good time to expect the call option might pay off when prices go back up?”

Looking at 30 years of corn prices, the risk is down at about $2.40 or $2.50 per bushel, Gold said back in December.

“We’re not running out of grain anywhere around the world, so we want to look for an opportunity to price it. In the meantime, we’ve got $4 puts for 25 cents in case we go to $2.50. While we’re hoping and praying for a rally, we’ve got that put option in our back pocket in case we go down.

“I don’t have a clue if wheat’s going back to $9 to $13 per bushel or coming down to $4. The risk is $4 wheat. We don’t know if soybeans are going to $16 to $18, or if they’re going down to $18. If U.S. farmers plant another 4 million acres of soybeans next year, and we have good yields, $6 soybeans won’t be out of the question. If we can buy an $8 to $10 put spread for 50 cents and protect that $2, that’s a 4:1 risk/reward ratio.”

U.S. farmers, says Gold, are getting ready to plant more of what the world wants less of. Price is likely to go down, and the only question is how far it will go.

“Within 18 months of any high, we’ve gone under the cost of production. If prices didn’t go back under the cost of production, you would have people buying up land and thinking it’s easy. You’ve got to force out the inefficient producer, and you do it by getting that cost back under production. It always has happened and it always will, so you’ve got to take advantage of the rallies.”

About the Author(s)

Paul L. Hollis

Auburn University College of Agriculture

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