Short-Dated Options
What’s Happened….
In 2012, the Chicago Board of Trade introduced short-dated options. The concept was simple. For corn, create an option in which the underlying futures month is December and for soybeans November, however, use multiple months for expiration dates. Months available start in October of the preceding year and are available every month through September. Traditional new crop options for corn and soybeans have respective expiration dates in November and October. Most options expire about 30 days before the last trading day for the underlying futures. The benefit of short-dated options, especially for producers, is they can buy an option that can be exercised to December corn or November soybeans and spend less money on time value as traditional options. As an example, say December corn rallies in late May. A farmer wants to buy a put for new crop (December) with protection for 30 days. In this example, rather than buy a traditional December put, he could purchase a short-dated July put.
Why is this important….
Short-dated options can reduce paying for the time value on traditional options. In addition, there are also strategies you can implement that, prior to short-dated options, were not available. This article will explore one such strategy that can either help farmers reduce the cost of owning longer-dated calls or create a position that can hedge expected crop with a long call to help manage risk of short futures. The numbers we use are for example purposes only and not reflective of current market conditions or prices.
The mechanics of this example strategy is to sell a corn short-dated June $4.90 call for 10 cents. At the same time, purchase a September $5.00 short-dated call for 20 cents. One of two events will occur at option expiration near the end of May. If December corn futures are below $4.90, the short June $4.90 call expires with the 10 cents (less commission and fees) credited to your account. The long September call is now in place for approximately 90 days until expiration. If prices were to rally and a farmer wanted to forward contract, he could do so with confidence knowing he has upside potential in the call position. If December futures are above $4.90 on expiration date of the June option, the June short call is exercised, and the farmer is assigned a short December futures at $4.90. The farmer still collects the sold premium, so he is essentially hedged December futures at $5.00 ($4.90 plus 10 cents less commission and fees) and still owns the long September short-dated call. If futures rallies to $6.00 at the expiration of the September call, he could exercise his long call, putting him long December futures at $5.00. This offsets the futures sold at $4.90. He would lose the 20 cents he paid for the long call and gain 10 cents from the short call. His unpriced cash corn was able to participate in the rally. He would then need to decide if he wanted to forward sell or take the risk on unpriced cash.
What can you do…
You can spend time understanding how short-dated options work and if they could be a part of your marketing toolbox. As with any tool or strategy, having a working knowledge of risk and potential is critical. Fine tune implementation with your advisor. Just like other tools you may use, whether on the farm or for marketing, knowing how and when to use them will give you confidence when it is time to implement.
About the Author: With the wisdom of 30 years at Total Farm Marketing and a following across the Grain Belt, Bryan Doherty is deeply passionate about his clients, their success, and long-term, fruitful relationships. As a senior market advisor and vice president of brokerage solutions, Doherty lives and breathes farm marketing. He has an in-depth understanding of the tools and markets, listens, and communicates with intent and clarity to ensure clients are comfortable with the decisions.
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