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Corn+Soybean Digest

Options Are For Beans

John McFarland usually isn't sold on using options to market soybeans. But with $8/bu. on the table and the chance for higher prices in early 2008, he changed his mind this year.

The eastern Kansas grower (near Ottawa) produces soybeans, corn and wheat. He sees better markets for soybeans based on fewer overall bean acres this year. He also sees a better opportunity for exports through sales into new container-loaded markets evolving at nearby Kansas City.

Unlike the nationwide trend, McFarland's bean acres are actually up for 2007 due to heavy spring rainfall that prevented some of his corn planting and delayed nearly all of it. “We'll have 300 more acres of beans this year, so we need to do a good job of marketing,” he says.

He started his '07 soybean marketing in late '06 when the market rallied. By mid-May of this year, he had about 40% of his projected crop marketed in the $7.75 range for cash sales and other delivery based on Nov. '07 futures. Much of that was for delivery into '08.

“We have about 90,000 bu. of on-farm storage available to help us stagger our sales,” he says. But since his soybean acres were higher along with prices, he had to look at additional sales opportunities. And it involved options.

For a floor price, he was looking at November $7.60 puts at a cost of about 25¢/bu. That would give him about a $7 floor, including the 25¢ premium and his minus-30¢ basis for later delivery.

He is also open to the upside, which if mid-year futures prices were any indication, showed promise for '08 prices well into the $8 range.

“We're probably going to look at more options due to the volatility of the futures market,” McFarland says, who works with Hurley & Associates marketing consultants. “I'm usually not big on options because they are too expensive. But the high volatility of futures makes it less comfortable for me to use a straight hedge.”

In late May, at-the-money $8.21 November '07 puts were 50¢/bu. for a 5,000-bu. contract. The $8 out-of-the-money put was even 41¢. Further out-of-the-money puts looked best to McFarland.

To help lower the price of options, McFarland is considering options spreads, using put and call options. “Spreads can reduce the amount you must pay for that floor price protection,” he says.

For example, in late spring, buying the $7.60 put for 25¢ would cost about $1,250 based on the 5,000-bu. contract, plus any brokerage fees. But by selling a $9.20 call for, say 27¢, the cost of the put is reduced substantially to virtually nothing.

The $7.60 floor will protect against a major slide in prices. However, with this strategy, $9.20 is the ceiling, so upside potential is restricted. But that's still a pretty wide window of opportunity, even with the volatile futures market. And if the ceiling price is surpassed, the increased value of his beans will likely offset any margin requirements that could result.

Growers should use caution in using option spreads to prevent “shrinking the value of their soybeans,” says Bob Wisner, Iowa State University grain marketing specialist.

“Be careful not to sell more calls than you are purchasing puts or you leverage up your risk of exposure,” he warns. For example, buying one put contract for 5,000 bu., then selling two calls at 10,000 bu. creates much more risk, he says.

“A few years back a broker recommended selling two calls for every put purchased (to lower the cost of price protection even more). That works if the market does not get above the call strike price,” Wisner says. “But if it does, you have two losses for every gain in cash value for your beans. You lower their value. Farmers need to clearly understand what they are doing.”

The value of on-farm storage or renting cheap storage has gone up with the escalation of corn, soybean and wheat prices. McFarland's 90,000-bu. storage capacity gives him the flexibility of capturing a higher basis and likely a higher overall price, based on seasonal price patterns.

McFarland normally sees a soybean basis of minus 40¢/bu. at harvest. That basis improves by about 15¢ if he holds off on marketing them a couple of months. Even with a normal storage cost of about 5¢/bu., it usually pays to hold on to the beans. He plans much of his marketing around the basis movement.

“We plan on selling only about 5% of our beans for harvest delivery,” he says. “They (grain handlers) ‘pay us’ to deliver later, so we market more of our beans into the following year.”

His average soybean yield is about 35 bu./acre. Delaying delivery to January or February can net him an extra $3-4/acre, based on the added 15¢ in basis, less the 5¢ storage cost.

“The usual tighter supply of soybeans early in the year can also mean a better price well above the harvest price or even a put option floor,” he says.

Wisner says storing beans well into '08 should provide profit potential. Basis levels are below normal and approach minus 70-75¢ in some areas, he says, but should improve 30-40¢ by mid-'08.

“We've had a big carry in soybeans,” he says. “Between the carry and the weak basis, the potential storage returns for storing from now to '08 could be a good alternative.”

Futures prices have been an indication of better things over the horizon. “July '07 futures were about $7.97/bu. in late May,” says Wisner, “but July '08 futures were $8.57. That 60¢ increase, plus the additional improvement in basis, could mean an extra 80¢ to $1/bu. for storing soybeans into the late spring of '08.”

McFarland sees better markets for soybeans in his region. “Some large grain companies are putting in a container loading facility at Kansas City,” he says, noting that such a move helps foreign buyers who are looking for a more efficient method of receiving grain imports and knowing their place or origin.

“I think we can do a lot better job of preserving our identity. The container loading facility gives us an opportunity to grow the kinds of soybeans that may work best for that kind of shipment,” he says.

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