TOP FARMER WEEKLY PERSPECTIVE 11/19/2021 BY BRYAN DOHERTY
Reasons to Use Call Options
The buyer of a call option has the right (not the obligation) to own the underlying futures contract. There may be multiple reasons why farmers might purchase a call option. For the purpose of this Perspective, we’ll take the viewpoint of a corn producer. As a producer of a commodity, your primary concern throughout much of the year is production-minded. However, call options are an important tool in your marketing toolbox that can help you manage your production’s value. The obvious goal of a marketer is to sell at the best price possible. To achieve this on a consistent basis is nearly impossible, as it would imply you can accurately outguess the market. A call option used in conjunction with cash marketing can help create what we term a balanced approach. With a call option, you could remain in a position to participate in a rally, nearly regardless of where the market moves.
One of the more common practices of using a call option is after cash sales are made. For example, you decided to sell cash, which means you can no longer benefit if the market price moves higher. The decision to sell cash may be one of many reasons: lack of storage or generating cash flow, to name a few. Whatever the reason, by purchasing a call option on sold bushels, you now have a retained ownership position. The benefit to you is that you can generate your cash flow and participate if prices move higher. This fall, corn prices have been stronger than usual, and the ability to sell at high cash prices currently exists. Still, you might hesitate to sell because if prices are high now, what might they be if weather conditions in South America suggest a shorter supply? If you decide not to sell, which is neither right nor wrong, you are subject to market risk, storage risk, and basis risk. By selling, you reduce all these risks, and you are no longer in the market. If you reinvest a portion of this sale into a call option for a time window that you desire, you can now participate in market moves. Your risk is subject to what is termed premium (the cost of the call option plus any associated commission and fees).
Another practice is to purchase a call option while still holding ownership. This position can be a bit risky, as your unsold cash bushels are at risk and the call option purchased is subject to lose its premium. This practice is incorporated if you believe the market can reach a certain price level and you know that you want to sell at that target. You are, in essence, pre-buying the bushels that you are intending to sell. If the cash market hits your price level and you sell, you now have your ownership already in place. This can be done with both old crop and expected crop for the year ahead. Buying a call option that is above the market is termed buying an out-of-the-money call. Some use this as a tool to be a disciplined seller. As marketers, farmers are likely evaluating news and events continually. Often when prices rally and are nearing a sell target, they are doing so for a reason. The temptation to cancel orders is heightened. By owning a call, there is less (or no) reason to cancel existing orders.
Call options, like forward selling or basis contracts, are just one of many tools in your marketing toolbox. Make sure you have a conversation with your advisor, who can help guide you in the selection of the call option as well as help you manage this position. Items to consider are cost, time, and ultimately the goal of what you’re trying to accomplish. Creating what we would term a balanced approach may help you achieve the goal of making desired cash sales and staying in the market.
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.