February traditionally can be slow time for farmers hoping to price crops they’ll plant in the spring. That certainty seems to be the case this year as well.
Nonetheless, for growers planning to make call options a part of their marketing efforts in 2020 it’s time to get started. Weak February futures prices stuck in the doldrums make calls more affordable now than they may be later during the growing season when weather risk can increase the cost of this insurance.
Owning calls may make it easier to sell because these options increase in value if futures rally enough. Proceeds from the positions can be added to the original selling price if that happens, raising the net revenue received.
This flexibility can be crucial in years when prices surge after sales are made. While using futures, HTAs or average price contracts does best in years of falling prices into harvest, these sales face huge losses if the market explodes higher. In 2012, for example, selling corn early brought average losses of $3.20 a bushel compared to the harvest price. Ouch!
Still, most calls, and put options as well, expire worthless, costs that lower the net selling price. That’s one reason options strategies generally under-perform other alternatives, like making sales solely with forward pricing tools like futures or cash forward contracts. Not only do options earn less on average. Since 1985, when ag options began trading again, these tools also beat the harvest cash price less often that most other strategies too.
This was the case for both corn and soybeans in 2019 according to Farm Futures long-term study of pre-harvest seasonal selling strategies. Selling corn futures or hedge-to-arrive contracts during seasonal windows beat the harvest price by 19 cents a bushel. All the strategies for soybeans lost money, but sales with futures, HTAs or average price contracts lost less than the option strategies.
Overall, 2019 confirmed both the strengths, and the limitation too, of pricing crops by the calendar.
Record slow planting and development provided hedging opportunities for corn growers willing to pull the trigger despite uncertain production. But the lingering effects of the trade war with China threw normal seasonal patterns for soybeans out of whack, keeping futures below profitable levels for the typical producer.
The study looks at three windows for selling. The second week of April and third week of May are used both crops. For corn, the third window comes in the last week of June. For soybeans, the final sales are pushed to mid-July.
The benefits of spreading out sales was apparent in corn. Sales in April and May netted little or lost money because December futures didn’t really rally until it was clear farmers wouldn’t be able to plant many fields. Futures peaked in the last half of June, right on schedule with their long-term pattern. This final increment was enough to boost average selling prices at the 11 locations included in the study.
While weather threatened soybeans, futures didn’t got back to highs reached over the winter, when China and the U.S. dug into to their tariff trenches. Traders never really worried about the supply of beans with so many questions about what demand would look like.
The unusual 2019 growing season offered another challenge. The late harvest meant November soybean and December corn options expired before many farmers finished harvest, leaving them unprotected. Still, options may have been prudent in a year when yields fell short of expectations for most producers. Hedging more than production was a real threat for those who sold too aggressively.
One way to lower the cost of that coverage is to leg into the trades, creating a so-called synthetic put by purchasing a call option during times of seasonal weakness to cover later sales. That strategy boosted long-term results even if didn’t work in 2019. Synthetic puts earned more on average than buying straight puts alone.
The first of these call buying windows comes at the end of February, with more purchased at the end of April and the end of May. So it’s time to make sure 2020 marketing plans are locked and loaded.
While November 2020 soybean futures have drifted a little higher after making eight-month lows at the start of February, implied volatility of options is cheap. This measure, which affects options’ pricing, is running near 14%, around 4% below average and not far from the 12.5% reading a year ago during the trade war.
Implied volatility for December 2020 corn is higher, around 18%, but that is also some 4% lower than average and close to the very weak February levels a year ago.
Implied volatility is a function of how much options sellers want to cover their risk, which is unlimited, and how much buyers are willing to pay in premiums for the insurance. In the grain market low implied volatility generally means traders don’t see much risk of rising prices. Whether or not they’re right is a drama that will play out in the months ahead.