TOP FARMER WEEKLY PERSPECTIVE 12/11/2020 BY BRYAN DOHERTY

Time for Call Options?

As of this writing, it looks like both the corn and soybean markets may have found their near-term price tops and are, at best, consolidating. Both markets posted negative reversals on charts November 30. Corn futures posted new highs that day and soybeans were within fractions of a cent of new contract highs. Since then, weather conditions in South America have taken a turn for the better and the last two weeks of export sales data has indicated a slowdown. Prices have reflected this by correcting, though they have not turned into a downtrend; at least not yet. In summary, prices are at a crossroads.

It may be time to get strategic in a more aggressive fashion. If you’re holding inventory, recognize that two or three events have happened this fall that are rare and usually don’t occur together. These are a price increase, holding or improving basis levels, and (for most farmers) a very good, if not great, crop.

Upward price momentum started in August, when investment money poured into commodities. They bought row crops, anticipating there was little room for prices to work lower. Exports boomed and technical buying ensued. Dry weather was developing in South America. We believe most producers sold soybeans out of the field and stored corn. The question now is: Can prices continue higher? If you sold, or are about to sell, how can you participate in upward price movement with quantified risk?

In this Perspective, we’ll coin the phrase “sell the fact and buy the potential.” Selling a strong basis in a price rise is not a common opportunity, especially at (or just after) harvest. The fact is that prices, even after a small set-back, are still higher than any other time this year. You are generating cash flow, reducing risk, and keeping a pay raise, all components of a good marketer. Yet, declining world inventories of both corn and soybeans, improved trade, and the potential for weather markets in South America and elsewhere loom large. Drought monitor maps continue to suggest both South and North America are experiencing tendencies of drier weather patterns.

To retain ownership of crops, consider purchasing call options. The buyer of a call has the right (not the obligation) to own futures. The purchase of a call has a fixed risk component, limited to what you pay for the option. You must decide how much time you want to buy (a pricing component) and at what level of ownership you desire (known as a strike price). Discuss these variables with your advisor. They will help guide you in the decision-making process.

As with any strategy, make sure you understand why you’re doing this and your potential exit avenues. Let’s look at a scenario and compare buying an option to buying futures. One component of call options that make them a good choice for many is holding power. That is, since the risk is fixed, you can hold your position through price downturns, knowing the worst-case scenario is that you lose the premium. If you buy futures and the market drops at some point, you’re likely to have a risk order triggered, or you may just decide to exit. If prices rally back, your idea to own was correct, though now you may be out of the market. In the same scenario with an option, if prices dropped then came back later before option expiration, you likely are still in the market because you probably didn’t exit the call option, as risk was fixed. The same scenario occurs with stored gain. If prices drop and don’t recover, you take the risk of lower prices, potential for widening basis, and cost of storage.

With volatility increasing this year and potential for prices to move strongly in either direction, make sure you approach marketing with a strategic mindset. Owning call options may be an important component of your marketing strategy.

If you have comments, questions, or suggestions, contact Bryan Doherty at Total Farm Marketing. You can reach him at 1-800-top-farm, extension 444.

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.

Author

Bryan Doherty