TOP FARMER WEEKLY PERSPECTIVE 7/9/2021 BY BRYAN DOHERTY

Using Puts to establish a Price Floor

Price rallies are welcomed, yet often stressful for farmers trying to make the right decision. Forward selling too much too soon brings regret to your decisions when better opportunities present themselves. That is a common story this year. “Reward rallies” is the mantra that many in the in the industry use, yet it is the farmer who decides and must accept the consequences, good or bad. In a year like this, where supplies have tightened and weather uncertainties keep the market volatile, it is difficult to make additional sales at higher prices when you may already have approached your forward contracting comfort level. A marketing tool that could be a big benefit to producers is purchasing put options.

When you purchase a put, you are buying an instrument that is traded at the Chicago Board of Trade and gives you the right (not the obligation) to sell futures. By purchasing a put, you establish a price floor. Yet, you have left your actual cash grain unpriced, and this can benefit from a price rally. Another way to view a put is to view it as buying insurance to guard against declining futures prices. Puts need to be purchased through a commodity broker who is licensed. Elevators may also offer a put, however, if they do, it will be in conjunction with an obligation to deliver cash grain. Therefore, if you desire to establish a floor without obligation of delivery, you will want to purchase your put through a commodity broker.

Let’s use an example. Say December corn futures are trading at $5.50. You like this price and are willing to forward contract up to 50% of your expected production. What about the other 50% that you intend to grow? This 50% is subject to the whim of the market movement. If prices go higher, you benefit because you have not priced. If prices go lower, you lose out from the opportunity to sell at a higher level. If prices move to $4 by harvest, you have great sales at $5.50 and harvest low sales at $4. Let’s say, instead of leaving half your crop unpriced, you purchased puts to cover that 50%. Say the put option costs $0.35 for commission and fees. In this example, the fall prices again drop to $4. Half your crop is sold at $5.50, and the other half of your crop has a floor at $5.15 ($5.50 – $0.35). The net combined average for your total production is $5.32-1/2. What if prices rally to $8.00? Again, half of your crop is sold at $5.50, and you sell the other half of your crop at $8.00. You need to subtract the $0.35 of cost for the put option. Your actual selling price on half the crop at harvest is $7.65. The average of both strategies combined is $6.57. As you can see, by purchasing put options on half of your expected production, you have kept yourself more balanced in the sense of shifting risk by establishing a price floor and, at the same time, leaving half your crop unpriced.

Before entering any strategy, make sure you have a thorough understanding and all questions answered. Knowledge is power. Knowing which tools to use at the right time can be of significant benefit for you in taming the volatility of a volatile market, yet taking advantage of higher pricing opportunities.

If you have comments, questions, or suggestions, contact Bryan Doherty at Total Farm Marketing. You can reach him at 1-800-334-9779, extension 300.

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