TOP FARMER WEEKLY PERSPECTIVE 04/14/2022 BY BRYAN DOHERTY
Time to Challenge the Market?
Options can be confusing. You can buy a put or a call, and you can sell a put or call. Selling options is called “option writing.” “Call writing” is selling a call option. Your goal in call writing is to collect premium. When you sell a call, you must be willing to accept a short futures contract due to an exercise. The option is exercised when the buyer of the option turns their long call into a long futures. That means you are assigned a short futures at the sold strike price. Whether your crop is in storage or you expect to produce it, selling call premium is a way to add to your bottom line.
At the option expiration date (last day for the option to trade), either the futures price of the underlying asset is below the call option strike price or above the option strike price. The futures price relative to the strike price will determine if the option buyer will exercise the option. If the futures price is below the option strike price, the option premium is reduced to zero and expires without value in your favor (you keep the premium). If the futures price is above the sold call strike price, you are assigned a short futures contract, and you keep the premium.
There are potential drawbacks. Call writing (selling a call) is considered an unlimited risk by exchanges, which means there is an initial margin requirement. Initial margin is a dollar deposit you must make in your commodity account as a good faith gesture to hold the position. If the call option gains value or the exchange decides to implement a higher margin requirement, additional funds may have to be deposited. This is called margin call. The good news is that the only way a short (sold) call can increase in value is for the market to move higher. Your unpriced inventory should gain value. (Note: there is a chance or risk that cash prices do not increase, or if they do, the cash price may not keep pace with rising futures.)
Let’s view an example. You sell a Dec $9.00 corn call option for 25 cents. At option expiration, November 25, 2022, if December corn futures are below $9.00, your account will show the option as expiring and the full 25 cents will be a credit in your account. On a 5,000-bushel contract, this is $1,250 less commissions and fees. If December futures is above $9.00, then you will be assigned a short December futures contract at $9.00 with premium collected. Breakeven is $9.25 less commission and fees. You will likely receive a higher price for your cash corn than the day you sold your option. Exiting the futures position above $9.25 will result in a loss in your account. Regardless of where December futures are on the last trading day for the option, you will collect the full premium. If December corn closes at $6.50 on expiration day, then your account will have the premium collected (less commission and fees) in your account.
Selling options is not for everyone. There is risk and potential for margin call and losses in your commodity account. Yet, if you can live with the idea of collecting premium and are willing to do this on a portion of expected production, this may make economic sense for you. With current futures prices at the top of an extended uptrend and on the eve of planting season, this may be a good time to consider this strategy. If planting goes well, history suggests prices probably run out of rally potential sooner than later.
In any case, be certain to understand the risks and rewards of this strategy. Talk to an advisor to help you implement a strategy that works best for your operation.
If you have any questions on this Perspective, feel free to contact Bryan Doherty at Total Farm Marketing: 800-334-9779.
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.