TOP FARMER INTELLIGENCE – Weekly Perspective by Bryan Doherty
SELL SOYBEANS – BUY A JULY BULL CALL SPREAD
If faced with a decision to commercially store soybeans or sell them, consider selling and retaining ownership. Selling beans generates cash flow and does away with market and basis risk as well as cost of storage. With storage, you are betting on not only price improvement, you are also taking on storage cost and basis risk. Another way to say this: it may be challenging to make money with commercial storage unless there is a big enough rally. You are taking on a lot of risk.
By selling your beans and reinvesting part of the cash flow into an option strategy, you are in the market with a quantified risk. By selling, you have probably accomplished what you most want to do: shift downside risk. With the bull call strategy, you now have upside potential in a re-ownership position with a fixed risk. A bull call spread consists of purchasing a call option and then, at the same time, selling a higher strike price call option. When purchasing a call, you are paying premium. When selling a call, you are collecting premium. The collected premium of the sold call is directly applied against the cost of the purchased call. As an example, if you purchased a July soybean call with a $9.60 strike price, you are buying the right to own beans at $9.60 and have until expiration date of June 26, 2020. The going cost, as of this writing, is 46 cents. By selling a $10.60 call with a going price of 16 cents, your net out-of-pocket cost is reduced to 30 cents (less commission and fees). On a side note, if you sell call options, you have unlimited risk and, therefore, a margin requirement. However, in this case, the only way the short call can gain value is if futures are increasing in value. By definition, your long call will gain value and will do so at a faster pace.
A bull call spread is a fixed profit position. Profit is limited to the difference between strike prices minus premium costs (less commission and fees). We view the bull call spread as a good add-on position after selling cash inventory, whether sales are accomplished through forward contracts or spot selling. You now have what we might term a more “balanced approach” where you have sold cash (risk reduction) and established an ownership stake in the futures market through the use of call options. In this case, a bull call spread.
As with any strategy, make sure you understand the risks and potential benefits associated before entering. Having a defined exit strategy is also highly recommended.
If you have questions or comments, contact Top Farmer at 1-800-TOP-FARMER extension 129. Ask for Bryan Doherty.
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.